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Encore Capital Group 10-Q 2008
Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2008

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             .

COMMISSION FILE NUMBER: 000-26489

 

 

ENCORE CAPITAL GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   48-1090909

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

8875 Aero Drive, Suite 200

San Diego, California

  92123
(Address of principal executive offices)   (Zip code)

(877) 445 - 4581

(Registrant’s telephone number, including area code)

(Not Applicable)

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the last 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨   Accelerated filer     x   Non-accelerated filer   ¨   Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

 

Outstanding at July 21, 2008

Common Stock, $0.01 par value   23,017,202 shares

 

 

 


Table of Contents

ENCORE CAPITAL GROUP, INC.

INDEX TO FORM 10-Q

 

     Page

PART I – FINANCIAL INFORMATION

   3

Item 1 – Condensed Consolidated Financial Statements (Unaudited)

   3

Condensed Consolidated Statements of Financial Condition

   3

Condensed Consolidated Statements of Operations

   4

Condensed Consolidated Statement of Stockholders’ Equity

   5

Condensed Consolidated Statements of Cash Flows

   6

Notes to Condensed Consolidated Financial Statements (Unaudited)

   8

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

   22

Supplemental Performance Data

   31

Liquidity and Capital Resources

   38

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

   40

Item 4 – Controls and Procedures

   40

PART II – OTHER INFORMATION

   41

Item 1 – Legal Proceedings

   41

Item 1A – Risk Factors

   42

Item 4 – Submission of Matters to a Vote of Security Holders

   44

Item 6 – Exhibits

   45

SIGNATURES

   46

 

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Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements (Unaudited)

ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Financial Condition

(In Thousands, Except Par Value Amounts)

(Unaudited)

 

     June 30,
2008
    December 31,
2007
 

Assets

    

Cash and cash equivalents

   $ 5,047     $ 4,900  

Restricted cash

     3,649       3,776  

Accounts receivable, net

     3,588       4,136  

Investment in receivable portfolios, net

     414,559       392,209  

Deferred court costs

     25,155       20,533  

Property and equipment, net

     5,344       4,390  

Prepaid income tax

     1,518       10,346  

Forward flow asset

     10,302       15,863  

Other assets

     8,180       8,800  

Goodwill

     15,985       15,985  

Identifiable intangible assets, net

     2,148       2,557  
                

Total assets

   $ 495,475     $ 483,495  
                

Liabilities and stockholders’ equity

    

Liabilities:

    

Accounts payable and accrued liabilities

   $ 20,156     $ 20,346  

Deferred tax liabilities, net

     13,659       13,669  

Deferred revenue and purchased servicing obligation

     4,370       3,898  

Debt

     265,635       272,420  

Other liabilities

     1,668       1,642  
                

Total liabilities

     305,488       311,975  
                

Commitments, contingencies and subsequent events

    

Stockholders’ equity:

    

Convertible preferred stock, $.01 par value, 5,000 shares authorized, no shares issued and outstanding

     —         —    

Common stock, $.01 par value, 50,000 shares authorized, 23,016 shares and 22,992 shares issued and outstanding as of June 30, 2008, and December 31, 2007, respectively

     230       230  

Additional paid-in capital

     76,963       73,310  

Accumulated earnings

     113,805       98,975  

Accumulated other comprehensive loss

     (1,011 )     (995 )
                

Total stockholders’ equity

     189,987       171,520  
                

Total liabilities and stockholders’ equity

   $ 495,475     $ 483,495  
                

See accompanying notes to unaudited condensed consolidated financial statements

 

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ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Operations

(In Thousands, Except Per Share Amounts)

(Unaudited)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2008     2007     2008     2007  

Revenues

        

Revenue from receivable portfolios, net

   $ 66,275     $ 64,021     $ 130,343     $ 126,174  

Servicing fees and other related revenue

     3,745       3,207       7,231       6,429  
                                

Total revenues

     70,020       67,228       137,574       132,603  
                                

Operating expenses

        

Salaries and employee benefits (excluding stock-based compensation expense)

     15,689       16,064       30,540       33,250  

Stock-based compensation expense

     1,228       1,204       2,322       2,005  

Cost of legal collections

     23,829       21,159       44,135       38,780  

Other operating expenses

     5,987       6,239       11,638       11,983  

Collection agency commissions

     3,781       2,867       7,812       6,161  

General and administrative expenses

     4,581       4,232       9,041       8,503  

Depreciation and amortization

     766       840       1,488       1,709  
                                

Total operating expenses

     55,861       52,605       106,976       102,391  
                                

Income before other (expense) income and income taxes

     14,159       14,623       30,598       30,212  
                                

Other (expense) income

        

Interest expense

     (3,583 )     (3,336 )     (7,529 )     (6,256 )

Contingent interest expense

     —         (888 )     —         (4,123 )

Pay-off of future contingent interest

     —         (11,733 )     —         (11,733 )

Gain on repurchase of convertible notes, net

     1,417       —         1,417       —    

Other income (expense)

     352       (42 )     373       74  
                                

Total other expense

     (1,814 )     (15,999 )     (5,739 )     (22,038 )
                                

Income (loss) before income taxes

     12,345       (1,376 )     24,859       8,174  

(Provision) benefit for income taxes

     (5,015 )     555       (10,029 )     (3,338 )
                                

Net income (loss)

   $ 7,330     $ (821 )   $ 14,830     $ 4,836  
                                

Weighted average shares outstanding:

        

Basic

     23,007       22,803       23,000       22,794  

Diluted

     23,512       22,803       23,468       23,388  

Earnings (loss) per share:

        

Basic

   $ 0.32     $ (0.04 )   $ 0.64     $ 0.21  

Diluted

   $ 0.31     $ (0.04 )   $ 0.63     $ 0.21  

See accompanying notes to unaudited condensed consolidated financial statements

 

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ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statement of Stockholders’ Equity

(Unaudited, In Thousands)

 

     Common Stock    Additional
Paid-In
Capital
    Accumulated
Earnings
   Accumulated
Other
Comprehensive
Loss
    Total
Equity
    Comprehensive
Income (loss)
 
     Shares    Par            

Balance at December 31, 2007

   22,992    $ 230    $ 73,310     $ 98,975    $ (995 )   $ 171,520    

Net income

   —        —        —         14, 830      —         14,830       14,830  

Other comprehensive loss:

                 

Unrealized loss on cash flow hedge, net of tax

   —        —        —         —        (16 )     (16 )     (16 )

Exercise of stock options

   7      —        8       —        —         8       —    

Issuance of share-based awards

   17      —        (36 )     —        —         (36 )     —    

Stock-based compensation

   —        —        2,322       —        —         2,322       —    

Tax provision related to stock option exercises

   —        —        (12 )     —        —         (12 )     —    

Tax benefit from convertible notes interest expense

   —        —        1,067       —        —         1,067       —    

Tax benefit from repurchase of convertible notes

   —        —        304       —        —         304       —    
                                                   

Balance at June 30, 2008

   23,016    $ 230    $ 76,963     $ 113,805    $ (1,011 )   $ 189,987     $ 14,814  
                                                   

See accompanying notes to unaudited condensed consolidated financial statements

 

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ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited, In Thousands)

 

     Six Months Ended
June 30,
 
     2008     2007  

Operating activities

    

Gross collections

   $ 206,485     $ 184,152  

Amounts collected on behalf of third parties

     (145 )     (266 )

Amounts applied to principal on receivable portfolios

     (75,997 )     (57,711 )

Provision for impairment (reversal)

     8,725       (1,263 )

Servicing fees

     61       64  

Operating expenses

     (99,572 )     (100,744 )

Interest payments

     (6,792 )     (6,010 )

Contingent interest payments

     —         (22,724 )

Other income

     373       74  

Decrease in restricted cash

     127       718  

Income tax refund (payments)

     236       (5,362 )

Tax provision (benefit) from stock-based payment arrangements

     12       (123 )
                

Net cash provided by (used in) operating activities

     33,513       (9,195 )
                

Investing activities

    

Purchases of receivable portfolios, net of forward flow allocation

     (94,833 )     (80,035 )

Collections applied to investment in receivable portfolios

     67,272       58,974  

Proceeds from put-backs of receivable portfolios

     2,047       1,574  

Purchases of property and equipment

     (2,034 )     (878 )
                

Net cash used in investing activities

     (27,548 )     (20,365 )
                

Financing activities

    

Proceeds from notes payable and other borrowings

     15,000       27,000  

Repayment of notes payable and other borrowings

     (17,169 )     (4,000 )

Repurchase of convertible notes

     (3,500 )     —    

Proceeds from exercise of stock options

     8       263  

Tax (provision) benefit from stock-based payment arrangements

     (12 )     123  

Repayment of capital lease obligations

     (145 )     (122 )
                

Net cash (used in) provided by financing activities

     (5,818 )     23,264  
                

Net increase (decrease) in cash

     147       (6,296 )

Cash and cash equivalents, beginning of period

     4,900       10,791  
                

Cash and cash equivalents, end of period

   $ 5,047     $ 4,495  
                

See accompanying notes to unaudited condensed consolidated financial statements

 

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ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Cash Flows (cont.)

Reconciliation of Net Income to Net Cash Provided by Operating Activities

(Unaudited, In Thousands)

 

     Six Months Ended
June 30,
 
     2008     2007  

Net income

   $ 14,830     $ 4,836  

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

    

Depreciation and amortization

     1,488       1,709  

Amortization of loan costs

     608       607  

Stock-based compensation expense

     2,322       2,005  

Gain on repurchase of convertible notes, net

     (1,417 )     —    

Tax benefit from repurchase of convertible notes

     304       —    

Tax benefit from convertible notes interest expense

     1,067       985  

Tax provision from stock option exercises

     (12 )     (107 )

Deferred income tax (benefit) expense

     (10 )     1,824  

Tax provision (benefit) from stock-based payment arrangements

     12       (123 )

Provision for impairment (reversal) on receivable portfolios, net

     8,725       (1,263 )

Changes in operating assets and liabilities

    

Decrease in restricted cash

     127       718  

Decrease in other assets

     1,008       255  

Increase in deferred court costs

     (4,622 )     (4,718 )

Decrease (increase) in prepaid income tax

     8,828       (4,352 )

Decrease in accrued profit sharing arrangement

     —         (6,869 )

Increase in deferred revenue and purchased service obligation

     472       158  

Decrease in accounts payable and accrued liabilities

     (217 )     (4,860 )
                

Net cash provided by (used in) operating activities

   $ 33,513     $ (9,195 )
                

See accompanying notes to unaudited condensed consolidated financial statements

 

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ENCORE CAPITAL GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1: Ownership, Description of Business and Summary of Significant Accounting Policies

Encore Capital Group, Inc. (“Encore”), through its subsidiaries (collectively, the “Company”), is a systems-driven purchaser and manager of charged-off consumer receivable portfolios and, through its wholly owned subsidiary Ascension Capital Group, Inc. (“Ascension”), a provider of bankruptcy services to the finance industry. The Company acquires its receivable portfolios at deep discounts from their face values using its proprietary valuation process that is based on the consumer attributes of the underlying accounts. Based upon the Company’s ongoing analysis of these accounts, it employs a dynamic mix of collection strategies to maximize its return on investment. The receivable portfolios the Company purchases consist primarily of unsecured, charged-off domestic consumer credit card, auto deficiency and telecom receivables purchased from national financial institutions, major retail credit corporations, telecom companies and resellers of such portfolios. Acquisitions of receivable portfolios are financed by operations and by borrowings from third parties. See Note 7 for further discussion of the Company’s debt.

Financial Statement Preparation

The accompanying interim condensed consolidated financial statements have been prepared by Encore, without audit, in accordance with the instructions to Form 10-Q, and Rule 10-01 of Regulation S-X promulgated by the Securities and Exchange Commission and, therefore, do not include all information and footnotes necessary for a fair presentation of its consolidated financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the United States. The condensed consolidated statements of financial condition at December 31, 2007 were derived from the audited financial statements at that date but do not include all disclosures required by accounting principles generally accepted in the United States.

In the opinion of management, the unaudited financial information for the interim periods presented reflects all adjustments, consisting of only normal and recurring adjustments, necessary for a fair presentation of the Company’s consolidated results of operations, financial position and cash flows. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007. Operating results for interim periods are not necessarily indicative of operating results for an entire fiscal year.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts and the disclosure of contingent amounts in the Company’s financial statements and the accompanying notes. Actual results could materially differ from those estimates.

Principles of Consolidation

The Company’s condensed consolidated financial statements include the assets, liabilities and operating results of its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Reclassification

Certain reclassifications have been made to the 2007 condensed consolidated statements of operations to separately show contingent interest expense and to the condensed consolidated statements of cash flows to separately show provisions for impairment and to separately show the change in other assets and the change in deferred court costs.

Changes in Accounting Estimate

Effective January 1, 2008, the Company revised its Unified Collection Score (“UCS”) and Behavioral Liquidation Score (“BLS”) methodologies by extending the collection forecast from 72 months to 84 months. UCS is a proprietary forecasting tool that generates portfolio level expectations of liquidation for portfolios that the Company has owned and serviced for greater than six months. BLS forecasts portfolio level expectations based on credit characteristics for portfolios owned and serviced less than six months. The Company has observed that receivable portfolios purchased in 2001 and prior have consistently experienced cash collections beyond 72 months from the date of purchase. When the Company first developed its cash forecasting models in 2001, limited historical collection data was available with which to accurately model projected cash flows beyond 60 months. During the quarter ended June 30, 2006, the Company determined there was enough additional collection data accumulated over the previous several years, in addition to improvements in its forecasting tools, allowing it to extend the collection forecast to 72 months. During the quarter ended March 31, 2008, the Company determined that there was enough additional collection data to accurately extend the collection forecast in both the UCS and BLS models to 84 months.

 

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The increase in the collection forecast from 72 to 84 months was applied effective January 1, 2008, to each portfolio for which the Company could accurately forecast through such term and resulted in an increase in the aggregate total estimated remaining collections for the receivable portfolios by $67.3 million, or 7.5%, as of March 31, 2008. The Company did not extend the forecast on telecom portfolios as it did not anticipate significant collections past 72 months on these portfolios. The extension of the collection forecast was being treated as a change in estimate and, in accordance with Statement of Financial Accounting Standard No. 154, “Accounting Changes and Error Corrections,” was recognized prospectively in the consolidated financial statements, effective January 1, 2008. In the quarter ended March 31, 2008, this prospective treatment resulted in a reduction in the Company’s net impairment provision of $3.1 million and an increase in revenue of $0.1 million. The impact of the change in estimate resulted in an increase in net income of $1.9 million and an increase in fully diluted earnings per share of $0.08 for the three months ended March 31, 2008. The impact of the change in estimate for the quarter ended June 30, 2008, was not material to the Company’s condensed consolidated financial statements.

Earnings per Share

Basic earnings per share (“EPS”) is calculated by dividing net earnings applicable to common stockholders by the weighted average number of shares of common stock outstanding. Common stock outstanding includes shares of common stock and restricted stock units for which no future service is required as a condition to the delivery of the underlying common stock. Diluted EPS includes the determinants of basic EPS and, in addition, reflects the dilutive effect of the common stock deliverable pursuant to stock options and to restricted stock units for which future service is required as a condition to the delivery of the underlying common stock. Employee stock options to purchase approximately 1,298,000 shares of common stock during the three months and six months ended June 30, 2008, and employee stock options to purchase approximately 1,181,000 and 1,277,000 shares of common stock during the three months and six months ended June 30, 2007, respectively, were outstanding but not included in the computation of diluted earnings per share because the effect on diluted earnings per share would be anti-dilutive.

Effects of New Accounting Pronouncement

In December 2007, the Financial Accounting Standard Board (the “FASB”) issued Statements No. 141 (revised 2007), “Business Combinations.” The new standard requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction, establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. The Company will adopt this new standard for its fiscal year beginning January 1, 2009.

In December 2007, the FASB issued Statement No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51.” This statement establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This statement is effective prospectively, except for certain retrospective disclosure requirements, for fiscal years beginning after December 15, 2008. The Company is currently analyzing the effects of the new standard and its potential impact, if any, on its consolidated financial statements.

In March 2008, the FASB issued Statement No. 161, “Disclosures about Derivative Instruments and Hedging Activities.” This new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company expects to adopt this new standard and its required disclosures, in its consolidated financial statements for the fiscal year beginning January 1, 2009.

In May 2008, the FASB issued FASB Staff Position (“FSP”) No. APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement).” This FSP requires that issuers of convertible debt instruments that, upon conversion, may be settled fully or partially in cash, must separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. This FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. This FSP is to be applied retrospectively to all past periods presented, even if the instrument has matured, converted, or otherwise been extinguished as of the FSP’s effective date. The Company believes that this FSP will change the accounting treatment of its current outstanding convertible senior notes, and result in a reduction in the carrying value of debt, an increase in equity, an increase in interest expense and a reduction in earnings per share.

 

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Note 2: Fair Value Measurements

On January 1, 2008, the Company adopted Statement of Financial Accounting Standard No. 157, “Fair Value Measurements” (“FAS 157”), for financial assets and liabilities. FAS 157 defines fair value, provides guidance for measuring fair value and requires certain disclosures. It does not require any new fair value measurements, but rather applies to all other accounting pronouncements that require or permit fair value measurements. The Company will adopt the provisions of FAS 157 for non-financial assets and non-financial liabilities that are recognized and disclosed at fair value on a nonrecurring basis for its fiscal year beginning January 1, 2009.

The fair values of the Company’s financial instruments reflect the amounts that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e. the “exit price”). The statement utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

 

   

Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.

 

   

Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

 

   

Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.

The Company’s financial instruments consist of the following:

Financial instruments with carrying value equal to fair value

 

   

Cash and cash equivalents

 

   

Accounts receivable

 

   

Hedged derivative instruments

The fair value of cash and cash equivalents and accounts receivable approximates their respective carrying value. Cash flow hedging instruments, which are considered over-the-counter derivatives, are also carried at their fair values. The Company’s fair value estimate for such derivative instruments incorporates quoted market prices at the balance sheet date from the counter party using significant observable inputs and is considered a level 2 fair value measurement.

Financial instruments not required to be carried at fair value

 

   

Investment in receivable portfolios, net

 

   

Deferred court costs

 

   

Forward flow asset

 

   

Long term debt

The Company has elected not to adopt the provisions of Statements of Financial Accounting Standard No. 159, “Fair Value Option,” for its fiscal year ended December 31, 2008. Therefore, the above instruments are not required to be recorded at their fair value. However, for disclosure purposes in connection with the provisions of Statements of Financial Accounting Standard No. 107, “Disclosures about Fair Value of Financial Instruments,” the Company is required to estimate the fair value of financial instruments when it is practical to do so. Borrowings under the Company’s revolving credit facility are carried at historical cost, adjusted for additional borrowings less principal repayments, which approximates fair value. The Company’s convertible senior notes are carried at a principal amount of $95.0 million at June 30, 2008. Their fair value estimate incorporates quoted market prices at the balance sheet date. However, the market for these securities is not active, and, therefore, results in a level 2 fair value measurement. As of June 30, 2008, the fair value estimate of the Company’s convertible senior notes based on quoted market prices amounts to approximately $72.2 million. For investment in receivable portfolios, deferred court costs and the forward flow asset, there is no active market or observable inputs for the fair value estimation. The Company considers it not practical to attempt to estimate the fair value of such financial instruments due to the excessive costs that would be incurred in doing so.

Note 3: Stock-Based Compensation

On January 1, 2006, the Company implemented Statement of Financial Accounting Standard No. 123R, “Share-Based Payment” (“FAS 123R”), which is a revision of Statement of Financial Accounting Standard No. 123, “Accounting For Stock-Based Compensation” (“FAS 123”), using the modified prospective approach. The adoption of FAS 123R requires all stock-based compensation to be recognized in the consolidated financial statements at fair value.

 

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On March 30, 2005, the Board of Directors of the Company adopted the 2005 Stock Incentive Plan (“2005 Plan”) for Board members, employees, officers, and executives of, and consultants and advisors to the Company. The 2005 Plan provides for the granting of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, performance shares, and performance-based awards to eligible individuals. Upon adoption, an aggregate of 1,500,000 shares of the Company’s common stock were available for awards under the 2005 Plan, plus ungranted shares of stock that were available for future awards under the 1999 Equity Participation Plan (“1999 Plan”). In addition, shares subject to options granted under either the 1999 Plan or the 2005 Plan that terminate or expire without being exercised are available for grant under the 2005 Plan. The benefits provided under these plans are share-based compensation subject to the provisions of FAS 123R.

In accordance with FAS 123R, compensation expense is recognized only for those shares expected to vest, with estimated forfeitures based on the Company’s historical experience and future expectations. For the six months ended June 30, 2008, $2.3 million was recognized as stock-based compensation expense.

The Company’s stock-based compensation arrangements are described below:

Stock Options

The 2005 Plan permits the granting of stock options to certain employees and directors of the Company. Option awards are generally granted with an exercise price equal to the market price of the Company’s stock at the date of issuance. Options generally vest based on three to five years of continuous service and have ten-year contractual terms.

The Company uses the Black-Scholes option-pricing model to determine the fair-value of stock-based awards. All options are amortized ratably over the requisite service periods of the awards, which are generally the vesting periods.

The fair value of options granted is estimated at the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions (there were no options granted during the six months ended June 30, 2008):

 

     Six Months Ended
June 30, 2008
   Six Months Ended
June 30, 2007
 

Weighted average fair value of options granted

   —      $ 7.52  

Risk free interest rate

   —        4.8 %

Dividend yield

   —        0.0 %

Volatility factor of the expected market price of the Company’s common stock

   —        79.0 %

Weighted-average expected life of options

   —        5 Years  

Unrecognized estimated compensation cost related to stock options as of June 30, 2008, was $1.6 million, which is expected to be recognized over a weighted-average period of approximately 2.3 years.

A summary of the Company’s stock option activity and related information is as follows for the six months ended June 30, 2008:

 

     Number of
Shares
    Option Price
Per Share
   Weighted
Average
Exercise
Price
   Aggregate
Intrinsic
Value
(in thousands)

Outstanding at December 31, 2007

   2,126,852     $ 0.35 -$20.09    $ 9.30   

Granted

   —              —     

Cancelled/forfeited

   (79,984 )     10.60 - 18.02      17.61   

Exercised

   (7,166 )     1.00 - 1.30      1.09   
                      

Outstanding at June 30, 2008

   2,039,702     $ 0.35 - $20.09    $ 9.00    $ 5,936
                      

Exercisable at June 30, 2008

   1,586,341     $ 0.35 -$20.09    $ 8.19    $ 5,936
                      

The total intrinsic value of options exercised during the six months ended June 30, 2008 and 2007 was $0.1 million and $0.2 million, respectively. As of June 30, 2008, the weighted-average remaining contractual life of options outstanding and options exercisable was 5.79 years and 5.11 years, respectively.

 

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Restricted Stock Units

Under the Company’s 2005 Plan, certain employees and directors are eligible to receive restricted stock units. In accordance with FAS 123R, the fair value of restricted stock units is equal to the closing price of the Company’s common stock on the date of issuance. The total number of restricted stock awards expected to vest is adjusted by estimated forfeiture rates. As of June 30, 2008, 154,150 of the non-vested shares are expected to vest over approximately three to five years based on certain performance goals (“Performance Shares”). The fair value of the Performance Shares is expensed over the expected vesting period based on the probability of performance goals being met. If performance goals are not expected to be met, the compensation expense previously recognized would be reversed. As of June 30, 2008, no reversals of compensation expense related to the Performance Shares have been made. The remaining 464,139 non-vested shares are not performance based, and will vest, and are being expensed over approximately two to five years.

For the six months ended June 30, 2008, restricted stock unit activity and related information is as follows:

 

Restricted Stock Units

   Non-Vested
Shares
    Weighted Average
Grant Date
Fair Value

Non-vested at December 31, 2007

   671,900     $ 11.28

Awarded

   14,686     $ 8.85

Vested

   (36,197 )   $ 10.66

Cancelled/forfeited

   (32,100 )   $ 11.79
            

Non-vested at June 30, 2008

   618,289     $ 11.23
            

Unrecognized estimated compensation cost related to restricted stock units as of June 30, 2008, was $3.5 million, which is expected to be recognized over a weighted-average period of approximately 2.8 years. The fair value of restricted stock units vested for the six months ended June 30, 2008 and 2007 was $0.2 million and less than $0.1 million, respectively.

Note 4: Investment in Receivable Portfolios, Net

In accordance with the provisions of AICPA Statement of Position 03-3, “Accounting for Certain Debt Securities in a Transfer” (“SOP 03-3”), discrete receivable portfolio purchases during a quarter are aggregated into pools based on common risk characteristics. Once a pool is established, the portfolios with common risk characteristics are permanently assigned to that pool. The discount (i.e., the difference between the cost of each pool and the related aggregate contractual receivable balance) is not recorded because the Company expects to collect a relatively small percentage of each pool’s contractual receivable balance. As a result, receivable portfolios are recorded at cost at the time of acquisition. All portfolios with common risk characteristics purchased prior to the adoption of SOP 03-3 in the first quarter of 2005 were aggregated by quarter of purchase.

In compliance with SOP 03-3, the Company accounts for its investments in consumer receivable portfolios using either the interest method or the cost recovery method. The interest method applies an effective interest rate, or IRR, to the cost basis of the pool, which remains unchanged throughout the life of the pool unless there is an increase or decrease in subsequent expected cash flows. Effective January 1, 2008, the IRR is based on the Company’s collection forecast up to 84 months from the date a portfolio is purchased. (See Note 1 for discussion of the Company’s extension of its collection forecast). Subsequent increases in cash flows expected to be collected are generally recognized prospectively through an upward adjustment of the pool’s IRR over its remaining life. Subsequent decreases in expected cash flows do not change the IRR, but are recognized as an impairment of the cost basis of the pool, and are reflected in the consolidated statements of operations as a reduction in revenue with a corresponding valuation allowance offsetting the investment in receivable portfolios in the consolidated statements of financial condition.

The Company accounts for each pool as a unit for the economic life of the pool (similar to one loan) for recognition of revenue from receivable portfolios, for collections applied to the cost basis of receivable portfolios and for provision for loss or impairment. Revenue from receivable portfolios is accrued based on each pool’s effective interest rate applied to each pool’s adjusted cost basis. The cost basis of each pool is increased by revenue earned and decreased by gross collections and impairments.

If the amount and timing of future cash collections on a pool of receivables are not reasonably estimable, the Company accounts for such portfolios on the cost recovery method (“Cost Recovery Portfolios”). The accounts in these portfolios have different risk characteristics than those included in other portfolios acquired during the same quarter, or the necessary information was not available to estimate future cash flows and, accordingly, they were not aggregated with other portfolios.

 

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Under the cost recovery method of accounting, no income is recognized until the purchase price of a Cost Recovery Portfolio has been fully recovered. In September 2007, the Company decided to exit its healthcare purchasing and collection activities. At that time, the Company anticipated either selling these healthcare portfolios or placing the underlying accounts with external agencies for collections. The Company no longer anticipates a sale of these receivable portfolios and has placed them with external collection agencies. Since the Company is no longer actively collecting on these accounts internally, it has classified them as Cost Recovery Portfolios. As of June 30, 2008, there were six portfolios accounted for using the cost recovery method, consisting of $1.3 million in net book value representing all of the healthcare portfolios that the Company had acquired. The $1.3 million is included in investment in receivable portfolios, net, which reflects the value the Company expects to realize through the collection activities of the external agencies.

Accretable yield represents the amount of revenue the Company expects to generate over the remaining life of its existing investment in receivable portfolios based on estimated future cash flows. Total accretable yield is the difference between future estimated collections and the current carrying value of a portfolio. All estimated cash flows on portfolios where the cost basis has been fully recovered are classified as zero basis cash flows.

The following tables summarize the Company’s accretable yield and an estimate of zero basis future cash flows at the beginning and end of the current period (in thousands):

 

     Six Months Ended June 30, 2008  
     Accretable
Yield
    Estimate of
Zero Basis
Cash Flows
    Total  

Beginning balance at December 31, 2007

   $ 486,652     $ 13,002     $ 499,654  

Revenue recognized, net

     (61,510 )     (2,558 )     (64,068 )

Reductions on existing portfolios

     (50,898 )     (1,015 )     (51,913 )

Additions for 12 months curve extension

     67,287       —         67,287  

Additions for current purchases

     112,780       —         112,780  
                        

Balance at March 31, 2008

   $ 554,311     $ 9,429     $ 563,740  

Revenue recognized, net

     (63,652 )     (2,623 )     (66,275 )

(Reductions) additions on existing portfolios

     (3,206 )     1,598       (1,608 )

Additions for current purchases

     79,159       —         79,159  
                        

Balance at June 30, 2008

   $ 566,612     $ 8,404     $ 575,016  
                        
     Six Months Ended June 30, 2007  
     Accretable
Yield
    Estimate of
Zero Basis
Cash Flows
    Total  

Beginning balance at December 31, 2006

   $ 417,981     $ 38,967     $ 456,948  

Revenue recognized, net

     (57,045 )     (5,108 )     (62,153 )

Additions (reductions) on existing portfolios

     20,438       (3,956 )     16,482  

Additions for current purchases

     52,980       —         52,980  
                        

Balance at March 31, 2007

   $ 434,354     $ 29,903     $ 464,257  

Revenue recognized, net

     (59,974 )     (4,047 )     (64,021 )

Additions on existing portfolios

     39,959       4,442       44,401  

Additions for current purchases

     58,837       —         58,837  
                        

Balance at June 30, 2007

   $ 473,176     $ 30,298     $ 503,474  
                        

During the three months ended June 30, 2008, the Company purchased receivable portfolios with a face value of $1.8 billion for $52.5 million, or a purchase cost of 2.9% of face value. The estimated future collections at acquisition for these portfolios amounted to $128.4 million. During the six months ended June 30, 2008, the Company purchased receivable portfolios with a face value of $3.0 billion for $100.4 million, or a purchase cost of 3.3% of face value. The estimated future collections at acquisition for these portfolios amounted to $246.8 million.

All collections realized after the net book value of a portfolio has been fully recovered (“Zero Basis Portfolios”) are recorded as revenue (“Zero Basis Revenue”). During the three months ended June 30, 2008 and 2007, approximately $2.6 million and $4.0 million were recognized as Zero Basis Revenue, respectively. During the six months ended June 30, 2008 and 2007, approximately $5.1 million and $9.2 million were recognized as Zero Basis Revenue, respectively.

 

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During the quarter ended March 31, 2008, the Company revised the forecasting methodology it uses to value a portfolio by extending the collection forecast from 72 months to 84 months. This change was made as a result of the Company’s increased confidence in its ability to forecast future cash collections to 84 months. Extending the collection forecast from 72 months to 84 months resulted in an increase in the aggregate total estimated remaining collections for the receivable portfolios as of March 31, 2008, by $67.3 million, or 7.5%.

The following tables summarize the changes in the balance of the investment in receivable portfolios during the six months ended June 30, 2008 (in thousands, except percentages):

 

     For the Six Months Ended June 30, 2008  
     Accrual Basis
Portfolios
    Cost Recovery
Portfolios
    Zero Basis
Portfolios
    Total  

Balance, beginning of period

   $ 390,564     $ 1,645     $ —       $ 392,209  

Purchases of receivable portfolios

     100,394       —         —         100,394  

Gross collections1

     (200,829 )     (330 )     (5,181 )     (206,340 )

Put-backs and recalls2

     (2,035 )     (12 )     —         (2,047 )

Revenue recognized3

     133,887       —         5,181       139,068  

Impairment, net 3

     (8,725 )     —         —         (8,725 )
                                

Balance, end of period

   $ 413,256     $ 1,303     $ —       $ 414,559  
                                

Revenue as a percentage of collections4

     66.7 %     0.0 %     100.0 %     67.4 %
                                
     For the Six Months Ended June 30, 2007  
     Accrual Basis
Portfolios
    Cost Recovery
Portfolios
    Zero Basis
Portfolios
    Total  

Balance, beginning of period

   $ 300,348     $ —       $ —       $ 300,348  

Purchases of receivable portfolios

     86,523       —         —         86,523  

Gross collections1

     (174,730 )     —         (9,156 )     (183,886 )

Put-backs and recalls2

     (1,574 )     —         —         (1,574 )

Revenue recognized3

     115,756       —         9,156       124,912  

Impairment reversals, net3

     1,263       —         —         1,263  
                                

Balance, end of period

   $ 327,586     $ —       $ —       $ 327,586  
                                

Revenue as a percentage of collections4

     66.2 %     0.0 %     100.0 %     67.9 %
                                

 

1

Does not include amounts collected on behalf of others.

2

Put-backs represent accounts that are returned to the seller in accordance with the respective purchase agreement (“Put-Backs”). Recalls represents accounts that are recalled by the seller in accordance with the respective purchase agreement (“Recalls”).

3

Reflects additional revenue of $0.1 million and a lower net impairment of $3.1 million, as a result of extending the collection curves from 72 to 84 months.

4

Revenue as a percentage of collections excludes the effects of net impairment or net impairment reversals.

The following table summarizes the change in the valuation allowance for investment in receivable portfolios during the six months ended June 30, 2008 (in thousands):

 

     Valuation
Allowance
 

Balance at December 31, 2007

   $ 15,752  

Provision for impairment losses

     5,335  

Reversal of prior allowance

     —    
        

Balance at March 31, 2008

   $ 21,087  

Provision for impairment losses

     3,557  

Reversal of prior allowance

     (167 )
        

Balance at June 30, 2008

   $ 24,477  
        

 

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The Company utilizes various business channels for the collection of its receivable portfolios. The following table summarizes collections by collection channel (in thousands):

 

     Three Months Ended June 30,    Six Months Ended June 30,
     2008    2007    2008    2007

Collection sites

   $ 38,929    $ 32,516    $ 82,218    $ 66,511

Legal collections

     49,184      44,430      94,476      84,160

Collection agencies

     10,009      7,686      20,970      16,503

Sales

     3,633      7,972      7,847      15,269

Other

     375      1,007      974      1,709
                           

Gross collections for the period

   $ 102,130    $ 93,611    $ 206,485    $ 184,152
                           

Note 5: Deferred Court Costs

The Company contracts with a nationwide network of attorneys that specialize in collection matters. The Company generally refers charged-off accounts to its contracted attorneys when it believes the related debtor has sufficient assets to repay the indebtedness and has, to date, been unwilling to pay. In connection with the Company’s agreement with the contracted attorneys, it advances certain out-of-pocket court costs (“Deferred Court Costs”). The Company capitalizes Deferred Court Costs in its consolidated financial statements and provides a reserve for those costs that it believes will ultimately be uncollectible. The Company determines the reserve based on its analysis of court costs that have been advanced and those that have been recovered. Deferred court costs not recovered within three years of placement are fully written off. Collections received from these debtors are first applied against related court costs with the balance applied to the debtors’ account.

Deferred Court Costs consist of the following as of the dates presented (in thousands):

 

     June 30,
2008
    December 31,
2007
 

Court costs advanced

   $ 116,635     $ 88,385  

Court costs recovered

     (29,900 )     (21,749 )

Court costs reserve

     (61,580 )     (46,103 )
                

Deferred court costs, net

   $ 25,155     $ 20,533  
                

Note 6: Other Assets

Other assets consist of the following (in thousands):

 

     June 30,
2008
   December 31,
2007

Debt issuance costs

   $ 2,491    $ 3,177

Deferred compensation assets

     2,704      3,158

Prepaid expenses

     1,515      785

Other

     1,470      1,680
             
   $ 8,180    $ 8,800
             

Note 7: Debt

The Company is obligated under borrowings as follows (in thousands):

 

     June 30,
2008
   December 31,
2007

Convertible senior notes

   $ 95,000    $ 100,000

Revolving credit facility

     170,000      172,169

Capital lease obligations and other debt

     635      251
             
   $ 265,635    $ 272,420
             

 

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Convertible Senior Notes

In 2005, the Company issued $100.0 million of 3.375% convertible senior notes due September 19, 2010 (the “Convertible Notes”). Interest on the Convertible Notes is payable semi-annually, in arrears, on March 19 and September 19 of each year. The Convertible Notes rank equally with the Company’s existing and future senior indebtedness and are senior to the Company’s potential future subordinated indebtedness. Prior to the implementation of the net-share settlement feature discussed below, the Convertible Notes were convertible, prior to maturity, subject to certain conditions described below, into shares of the Company’s common stock at an initial conversion rate of 44.7678 per $1,000 principal amount of notes, which represented an initial conversion price of approximately $22.34 per share, subject to adjustment.

In April 2008, the Company repurchased $5.0 million principal amount of its outstanding Convertible Notes, for a total price of $3.5 million, plus accrued interest. This transaction left $95.0 million principal amount of the Company’s Convertible Notes outstanding, and resulted in a net gain of $1.4 million in the second quarter of 2008. As of June 30, 2008, the Company is making the required interest payments on the Convertible Notes and no other changes in the balance or structure of the Convertible Notes has occurred.

In October 2005, the Company obtained stockholder approval of a net-share settlement feature that allows the Company to settle conversion of the Convertible Notes through a combination of cash and stock. Based on the provisions of Emerging Issues Task Force No. 90-19, “Convertible Bonds with Issuer Option to Settle for Cash upon Conversion” (“EITF 90-19”), and Emerging Issues Task Force No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled In, a Company’s Own Stock” (“EITF 00-19”), the net-settlement feature is accounted for as convertible debt and is not subject to the provisions of Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS 133”). As a result of the net-settlement feature, the Company will be able to substantially reduce the number of shares issuable in the event of conversion of the Convertible Notes by repaying principal in cash instead of issuing shares of common stock for that amount. Additionally, the Company will not be required to include the underlying shares of common stock in the calculation of the Company’s diluted weighted average shares outstanding for earnings per share until the Company’s common stock price exceeds $22.34.

The aggregate underwriting commissions and other debt issuance costs incurred with respect to the issuance of the Convertible Notes were $3.4 million, which have been capitalized as debt issuance costs on the Company’s consolidated statements of financial condition and are being amortized using the effective interest rate method over the term of the Convertible Notes.

The Convertible Notes also contain a restricted convertibility feature that does not affect the conversion price of the Convertible Notes but, instead, places restrictions on a holder’s ability to convert their Convertible Notes into shares of the Company’s common stock. A holder may convert the Convertible Notes prior to March 19, 2010, only if one or more of the following conditions are satisfied:

 

   

the average of the trading prices of the Convertible Notes for any five consecutive trading day period is less than 103% of the average of the conversion values of the Convertible Notes during that period;

 

   

the Company makes certain significant distributions to holders of the Company’s common stock;

 

   

the Company enters into specified corporate transactions; or

 

   

the Company’s common stock ceases to be approved for listing on the NASDAQ National Market and is not listed for trading on a U.S. national securities exchange or any similar U.S. system of automated securities price dissemination.

Holders may also surrender their Convertible Notes for conversion anytime on or after March 19, 2010, until the close of business on the trading day immediately preceding September 19, 2010, regardless of whether any of the foregoing conditions have been satisfied. Upon the satisfaction of any of the foregoing conditions, on the last day of a reporting period, or during the twelve months prior to September 19, 2010, the Company would write off to expense all remaining unamortized debt issuance costs in that period.

If the Convertible Notes are converted in connection with certain fundamental changes that occur prior to March 19, 2010, the Company may be obligated to pay an additional make-whole premium with respect to the Convertible Notes converted.

Convertible Notes Hedge Strategy. Concurrent with the sale of the Convertible Notes, the Company purchased call options to purchase from the counterparties an aggregate of 4,476,780 shares of the Company’s common stock at a price of $22.34 per share. The cost of the call options totaled $27.4 million. The Company also sold warrants to the same counterparties to purchase from the Company an aggregate of 3,984,334 shares of the Company’s common stock at a price of $29.04 per share and received net proceeds from the sale of these warrants of $11.6 million. Taken together, the call option and warrant agreements have the effect of increasing

 

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the effective conversion price of the Convertible Notes to $29.04 per share. The call options and warrants must be settled in net shares, except in connection with certain termination events, in which case they would be settled in cash based on the fair market value of the instruments. On the date of settlement, if the market price per share of the Company’s common stock is above $29.04 per share, the Company will be required to deliver shares of its common stock representing the value of the call options and warrants in excess of $29.04 per share.

The warrants have a strike price of $29.04 and are generally exercisable at anytime. The Company issued and sold the warrants in a transaction exempt from the registration requirements of the Securities Act of 1933, as amended, because the offer and sale did not involve a public offering. There were no underwriting commissions or discounts in connection with the sale of the warrants. In accordance with EITF No. 00-19 and Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” the Company recorded the net call options and warrants as a reduction in additional paid in capital as of December 31, 2005, and will not recognize subsequent changes in fair value of the call options and warrants in its consolidated financial statements.

Revolving Credit Facility

During 2005, the Company entered into a three-year revolving credit facility (“Revolving Credit Facility”), to be used for the purposes of purchasing receivable portfolios and for general working capital needs. This Revolving Credit Facility has been amended several times to meet the needs of the Company, and is due to expire in May 2010.

Effective February 27, 2007, and May 9, 2008, the Company amended the Revolving Credit Facility to allow for the Company to repurchase up to $50 million of a combination of its common stock and Convertible Notes, subject to compliance with certain covenants and available borrowing capacity.

Effective May 7, 2007, the Company amended the Revolving Credit Facility in connection with an agreement reached with the lender under the Company’s Secured Financing Facility. This amendment allows the Company to exclude the expense associated with a one-time payment of $16.9 million in connection with its termination of all future obligations under its Secured Financing Facility as further discussed below.

Effective October 19, 2007, the Company amended the Revolving Credit Facility to change the definition of “change of control” to exclude from that definition acquisitions of stock by Red Mountain Capital Partners LLC (“Red Mountain”), JCF FPK I LP (“JCF FPK”) and their respective affiliates. The amendment was entered into in contemplation of a shareholders’ agreement between Red Mountain affiliates and JCF FPK. This agreement was subsequently executed.

Effective July 3, 2008, the Company amended the Revolving Credit Facility to expand the capacity from $230.0 million to $335.0 million. This amendment added three additional lenders and increased the applicable margin under certain circumstances between 25 and 75 basis points. Refer to Note 12 for further details on this amendment.

Other provisions of the amended Revolving Credit Facility include:

 

   

Interest at a floating rate equal to, at the Company’s option, either: (a) reserve adjusted LIBOR plus a spread that ranges from 225 to 275 basis points, depending on the Company’s leverage; or (b) the higher of the federal funds rate then in effect plus a spread of 50 basis points or the prime rate plus a spread that ranges from 25 to 75 basis points.

 

   

$5.0 million sub-limits for swingline loans and letters of credit.

 

   

A borrowing base that provides for an 85.0% initial advance rate for the purchase of qualified receivable portfolios. The borrowing base reduces for each qualifying portfolio by 3% per month beginning after the third complete month subsequent to the initial purchase. The aggregate borrowing base is equal to the lesser of (a) the sum of all of the borrowing bases of all qualified receivable portfolios under this facility, as defined above, or (b) 95% of the net book value of all receivable portfolios acquired on or after January 1, 2005.

 

   

Restrictions and covenants, which limit, among other things, the payment of dividends and the incurrence of additional indebtedness and liens.

 

   

Events of default which, upon occurrence, may permit the lenders to terminate the Revolving Credit Facility and declare all amounts outstanding to be immediately due and payable.

 

   

Collateralization by all assets of the Company.

At June 30, 2008, the outstanding balance on the Revolving Credit Facility was $170.0 million, which bore a weighted average interest rate of 5.54%. The aggregate borrowing base was $230.0 million, of which $60.0 million was available for future borrowings. Effective July 3, 2008, the aggregate borrowing base was expanded to $335.0 million.

 

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Secured Financing Facility

The Company repaid in full the principal balance of the Secured Financing Facility at the end of 2006 and will make no further borrowings under that facility. Prior to May 7, 2007, the Company and the lender shared the residual collections, net of servicing fees paid to the Company. The residual collections paid to the lender were classified as contingent interest (“Contingent Interest”).

On May 7, 2007, the Company entered into an agreement with the lender under its Secured Financing Facility to eliminate all future Contingent Interest payments, for a one-time payment of $16.9 million. This agreement released the lender’s security interests in the remaining receivables originally financed under the Secured Financing Facility. Subsequent to the second quarter of 2007, the Company is no longer obligated to make any Contingent Interest payments under the Secured Financing Facility and, as a result, no longer records such interest in its statements of operations.

The following table summarizes interest expense associated with the Secured Financing Facility for the periods presented (in thousands):

 

     Three Months Ended June 30,    Six Months Ended June 30,
     2008    2007    2008    2007

Contingent interest

   $ —      $ 888    $ —      $ 4,123

Pay-off of contingent interest

     —        11,733      —        11,733
                           

Total

   $ —      $ 12,621    $ —      $ 15,856
                           

Derivative Instruments

On April 11, 2007, the Company entered into two separate interest rate swap agreements intended to more effectively manage interest rates by establishing a set level of fixed rates associated with a portion of the borrowings under its Revolving Credit Facility. The first agreement is for a notional amount of $25.0 million, a term of three years and a fixed interest rate of 4.99%. The second agreement is for a notional amount of $25.0 million, a term of four years and a fixed interest rate of 5.01%. Giving effect to these hedges, the interest rate the Company will pay on $50.0 million of the outstanding balance under the Revolving Credit Facility will be the fixed interest rates mentioned above plus the required credit spread.

FAS 133 requires that the derivatives be recorded on the balance sheet as either an asset or liability measured at its fair value. The effective portion of the change in fair value of the derivative is recorded in other comprehensive income. The ineffective portion of the change in fair value of the derivative, if any, is recognized in interest expense in the period of change. From the inception of the hedging program, the Company has determined that the hedging instruments are highly effective. Accordingly, for the six months ended June 30, 2008, the Company has recorded the change in fair value as other comprehensive loss. As of June 30, 2008, the fair value of the hedges represented a liability of $1.7 million and is included in other liabilities and accumulated other comprehensive loss.

The amount recorded in accumulated other comprehensive loss related to cash flow hedging instruments was as follows (in thousands):

 

     Accumulated Other
Comprehensive
(Loss) Income
 

Beginning balance at December 31, 2007

   $ (995 )

Changes in fair value of derivatives

     (26 )

Deferred income tax benefit

     10  
        

Ending balance at June 30, 2008

   $ (1,011 )
        

Capital Lease Obligations and Other Debt

The Company has capital lease obligations for certain computer equipment. These lease obligations require monthly payments aggregating approximately $21,000 through November 2008 and have implicit interest rates ranging from 2.9% to 3.1%.

The Company finances certain leasehold improvement projects with its lessors in its Phoenix and St. Cloud facilities. These projects are currently under construction and, as of June 30, 2008, the Company’s obligation was approximately $0.5 million. Commencing in October 2008, these financing agreements require monthly principal and interest payments, accrue interest at 8%—9% per annum and will mature in June and September 2013.

 

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Note 8: Income Taxes

The Company recorded an income tax provision of $5.0 million, reflecting an effective rate of 40.6% of pretax income during the three months ended June 30, 2008. The effective tax rate for the three months ended June 30, 2008, consists primarily of a provision for Federal income taxes of 32.1% (which is net of a benefit for state taxes of 2.9%), a provision for state taxes of 8.2% and a provision for the effect of permanent book versus tax differences of 0.3%. For the three months ended June 30, 2007, the Company recorded an income tax benefit of $0.6 million, reflecting an effective rate of 40.3% of pretax income. The effective tax rate for the three months ended June 30, 2007, consists primarily of a benefit for Federal income taxes of 31.9% (which is net of a provision for state taxes of 3.1%), a benefit for state taxes of 8.8% and a provision for the effect of permanent book verses tax differences of 0.4%.

The Company recorded an income tax provision of $10.0 million, reflecting an effective rate of 40.3% of pretax income during the six months ended June 30, 2008. The effective tax rate for the six months ended June 30, 2008, consists primarily of a provision for Federal income taxes of 32.1% (which is net of a benefit for state taxes of 2.9%) and a provision for state taxes of 8.2%. For the six months ended June 30, 2007, the Company recorded an income tax provision of $3.3 million, reflecting an effective rate of 40.8% of pretax income. The effective tax rate for the six months ended June 30, 2007, consists primarily of a provision for Federal income taxes of 31.9% (which is net of a benefit for state taxes of 3.1%), a provision for state taxes of 8.8% and the effect of permanent book verses tax differences of 0.1%.

Effective January 1, 2007, the Company adopted the provisions of Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). As of December 31, 2007, the Company had a gross unrecognized tax benefit of $1.3 million that, if recognized, would result in a net tax benefit of approximately $1.0 million and would have a positive effect on the Company’s effective tax rate. During the three and six months ended June 30, 2008, there were no material changes to the unrecognized tax benefit.

For the three months ended June 30, 2008, the Company has not provided for the United States income taxes or foreign withholding taxes on the quarterly undistributed earnings from continuing operations of its subsidiary operating outside of the United States. Undistributed earnings of the subsidiary for the three and six months ended June 30, 2008, were approximately $0.1 million and $0.3 million, respectively. Such undistributed earnings are considered permanently reinvested.

The Company’s subsidiary operating outside of the United States is currently operating under a tax holiday in India. The tax holiday is due to expire on March 31, 2010. The impact of the tax holiday on the Company’s consolidated financial statements is immaterial.

Note 9: Purchase Concentrations

The following table summarizes the concentration of the Company’s purchases by seller sorted by total aggregate costs for the six months ended June, 2008 and 2007 (in thousands, except percentages):

 

     Concentration of Initial
Purchase Cost by Seller
For The Six Months Ended
 
     June 30, 2008     June 30, 2007  
     Cost     %     Cost     %  

Seller 1

   $ 33,334     33.2 %   $ 32,142     37.2 %

Seller 2

     26,772     26.7 %     —       0.0 %

Seller 3

     11,404     11.4 %     —       0.0 %

Seller 4

     8,248     8.2 %     1,200     1.4 %

Seller 5

     7,057     7.0 %     7,260     8.4 %

Other

     13,579     13.5 %     45,921     53.0 %
                            
   $ 100,394     100.0 %   $ 86,523     100.0 %

Adjustments1

     (54 )       (130 )  
                    

Purchases, net

   $ 100,340       $ 86,393    
                    

 

1

Adjusted for Put-backs and Recalls.

 

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Note 10: Commitments and Contingencies

Litigation

On October 18, 2004, Timothy W. Moser, one of the Company’s former officers, filed an action in the United States District Court for the Southern District of California against the Company, and certain individuals, including several of the Company’s officers and directors. On February 14, 2005, the Company was served with an amended complaint in this action alleging defamation, intentional interference with contractual relations, breach of contract, breach of the covenant of good faith and fair dealing, intentional and negligent infliction of emotional distress and civil conspiracy arising out of certain statements in the Company’s Registration Statement on Form S-1 originally filed in September 2003 and alleged to be included in the Company’s Registration Statement on Form S-3 originally filed in May 2004. The amended complaint seeks injunctive relief, economic and punitive damages in an unspecified amount plus an award of profits allegedly earned by the defendants and alleged co-conspirators as a result of the alleged conduct, in addition to attorney’s fees and costs. On May 2, 2006, the court denied the Company’s special motion to strike pursuant to California’s anti-SLAPP statute, denied in part and granted in part the Company’s motion to dismiss, denied a variety of ex parte motions and applications filed by the plaintiff and denied the plaintiff’s motion for leave to conduct discovery or file supplemental briefing. The court granted the plaintiff 30 days in which to further amend his complaint, and on June 1, 2006, the plaintiff filed a second amended complaint in which he amended his claim for negligent infliction of emotional distress. On May 25, 2006, the Company filed a notice of appeal of the court’s order denying the anti-SLAPP motion and on June 16, 2006, the Company filed a motion to stay the case pending the outcome of the appeal, which was granted. Oral argument on the appeal was heard on July 17, 2008, and on July 28, 2008, the appellate court affirmed the trial court’s denial of the Company’s anti-SLAAP motion. As a consequence, the Company will determine whether or not to seek a rehearing of the appeal. If the Company does not determine to seek a rehearing, the case will be returned to the district court where it will proceed from the point at which it was stayed. Management of the Company believes the claims are without merit and intends to vigorously defend the action. Although the outcome of this matter cannot be predicted with certainty, management does not currently believe that this matter will have a material adverse effect on the Company’s consolidated financial position or results of operations.

On September 7, 2005, Mr. Moser filed a related action in the United States District Court for the Southern District of California against Triarc Companies, Inc. (“Triarc”), which at the time was a significant stockholder of the Company, alleging intentional interference with contractual relations and intentional infliction of emotional distress. The case arises out of the same statements made or alleged to have been made in the Company’s Registration Statements mentioned above. On January 7, 2006, Triarc was served with an amended complaint seeking injunctive relief, an order directing Triarc to issue a statement of retraction or correction of the allegedly false statements, economic and punitive damages in an unspecified amount and attorney’s fees and costs. Triarc tendered the defense of this action to the Company, and the Company accepted the defense and will indemnify Triarc, pursuant to the indemnification provisions of the Registration Rights Agreements dated as of October 31, 2000 and February 21, 2002, and the Underwriting Agreements dated September 25, 2004 and January 20, 2005 to which Triarc is a party. Although the outcome of this matter cannot be predicted with certainty, management does not currently believe that this matter will have a material adverse effect on the Company’s consolidated financial position or results of operations.

Claims based on the Fair Debt Collection Practices Act (“FDCPA”) and comparable state statutes may result in class action lawsuits, which can be material to the Company due to the remedies available under these statutes, including punitive damages. A number of cases styled as class actions have been filed against the Company. A class has been certified in several of these cases. Several of these cases present novel issues on which there is no legal precedent. As a result, the Company is unable to predict the range of possible outcomes. There are a number of other lawsuits, claims and counterclaims pending or threatened against the Company. In general, these lawsuits, claims or counterclaims have arisen in the ordinary course of business and involve claims for actual damages arising from alleged misconduct or improper reporting of credit information by the Company or its employees or agents. Although litigation is inherently uncertain, based on past experience, the information currently available and the possible availability of insurance and/or indemnification in some cases, management of the Company does not believe that the currently pending and threatened litigation or claims will have a material adverse effect on the Company’s consolidated financial position or results of operations. However, future events or circumstances, currently unknown to management, will determine whether the resolution of pending or threatened litigation or claims will ultimately have a material effect on the Company’s consolidated financial position, liquidity or results of operations in any future reporting periods.

 

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Purchase Commitments

In connection with the Company’s acquisition of certain assets of Jefferson Capital Group in June 2005, the Company entered into a forward flow agreement to purchase a minimum of $3.0 billion in face value of credit card charge-offs over a five-year period at a fixed price. As of June 30, 2008, future minimum purchase commitments under this agreement are as follows (amounts in thousands):

 

2008   2009   2010   Total
$ 12,836   $ 25,672   $ 12,836   $ 51,344
                     

The purchase commitment above assumes that the remaining commitment as of June 30, 2008, will be incurred ratably over the remaining term of such agreement.

On July 15, 2008, the Company gave Jefferson Capital Group and its parent company, CompuCredit Corporation, notice of breach by Jefferson Capital and CompuCredit of the agreement under which the forward flow purchases are made and initiated arbitration as a result of the breach. Management does not believe that the Company will ultimately make the forward flow purchases identified above as a result of the breach by Jefferson Capital and CompuCredit. See Note 12, “Subsequent Events,” for more information on our dispute with Jefferson Capital and CompuCredit.

Note 11: Securities Repurchase Program

On February 27, 2007, the Company’s board of directors authorized a securities repurchase program under which the Company may buy back up to $50 million of a combination of its common stock and Convertible Notes. The purchases may be made from time to time in the open market or through privately negotiated transactions and will be dependent upon various business and financial considerations. Securities repurchases are subject to compliance with applicable legal requirements and other factors. During April 2008, the Company repurchased $5.0 million principal amount of its outstanding Convertible Notes, for a total of $3.5 million, plus accrued interest.

Note 12: Subsequent Events

Effective July 3, 2008, the Company amended its Revolving Credit Facility to expand the $230.0 million senior secured revolving credit facility by increasing the accordion feature to provide for an additional $105.0 million in availability, resulting in capacity of $335.0 million. This amendment also added three additional lenders and increased the applicable margin under certain circumstances between 25 and 75 basis points.

On July 15, 2008, the Company gave Jefferson Capital Group and its parent Company, CompuCredit Corporation, notice of breach by Jefferson Capital and CompuCredit of the Asset Purchase and Forward Flow Agreement dated June 2, 2005, as amended, as well as a related Collection Agreement dated the same date. On July 16, 2008, the Company initiated arbitration as a result of the breach, pursuant to the arbitration provisions of the Agreements. The Company asserts that the litigation initiated by the Federal Trade Commission (the “FTC”) on June 11, 2008, wherein the FTC alleges that Jefferson Capital and CompuCredit have violated the FTC Act with deceptive marketing practices in selling credit cards, among other allegations, violates the Asset Purchase and Forward Flow Agreement and Collection Agreement. The Company seeks an arbitral award that (i) Jefferson Capital and CompuCredit are in material breach of the Agreements, (ii) declares the Company’s obligations to purchase forward flow accounts under the Agreements is thereby excused or discharged, (iii) confirms the Company’s rights to cause Jefferson Capital to repurchase certain accounts previously sold to the Company under the Agreements, and other appropriate relief, including return of prepaid amounts relating to forward flow purchases, (iv) confirms the Company’s rights to indemnity by Jefferson Capital and CompuCredit and (v) awards compensatory damages, attorney fees, interest, arbitration costs and other appropriate relief.

The Company has just commenced the Arbitration proceedings and no Arbitrator(s) have as yet been identified. In the interim, the Company has ceased forward flow purchases of accounts from Jefferson Capital, the sale of bankrupt accounts to Jefferson Capital and participation in a balance transfer program with CompuCredit. In response to the Notice of Breach from the Company, Jefferson Capital and CompuCredit delivered its own Notice of Default to the Company alleging the breach by the Company of the Company’s forward flow purchase, bankruptcy sale and balance transfer obligations.

This matter is in the early stages of development and any impact on the recoverability of the Company’s forward flow asset, currently stated at $10.3 million, is uncertain. The consolidated financial statements do not include any adjustment that might result from the outcome of this uncertainty.

 

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Item 2.        Management’s Discussion and Analysis of Financial Condition and Results of Operations

This information should be read in conjunction with the condensed consolidated financial statements and the notes thereto included in Item 1 of Part I of this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2007 contained in our 2007 Annual Report on Form 10-K. The Form 10-K contains a general description of our industry and a discussion of recent trends affecting the industry. Certain statements herein may constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995 (the “Reform Act”), for which we claim the protection of the safe harbor of the Reform Act. See “Part II, Item 1A—Risk Factors” for more discussion on our forward-looking statements.

Introduction

We are a systems-driven purchaser and manager of charged-off consumer receivable portfolios and a provider of bankruptcy services to the finance industry. We acquire receivable portfolios at deep discounts from their face values using our proprietary valuation process that is based on the consumer attributes of the underlying accounts. Based upon the ongoing analysis of these accounts, we employ a dynamic mix of collection strategies to maximize our return on investment.

Purchases and Collections

Purchases by Paper Type

The following table summarizes the types of charged-off consumer receivable portfolios we purchased for the three and six months ended June 30, 2008 and 2007 (in thousands):

 

     Three Months Ended June 30,    Six Months Ended June 30,
     2008    2007    2008    2007

Credit card

   $ 40,165    $ 35,666    $ 85,445    $ 80,261

Other

     12,327      5,471      14,949      6,262
                           
   $ 52,492    $ 41,137    $ 100,394    $ 86,523
                           

During the three months ended June 30, 2008, we invested $52.5 million for portfolios with face values aggregating $1.8 billion for an average purchase price of 2.9% of face value. This is an $11.4 million increase, or 27.8%, in the amount invested, compared with the $41.1 million invested during the three months ended June 30, 2007, to acquire portfolios with a face value aggregating $1.3 billion for an average purchase price of 3.1% of face value.

During the six months ended June 30, 2008, we invested $100.4 million for portfolios with face values aggregating $3.0 billion for an average purchase price of 3.3% of face value. This is a $13.9 million increase, or 16.1%, in the amount invested compared with the $86.5 million invested during the six months ended June 30, 2007, to acquire portfolios with a face value aggregating $3.9 billion for an average purchase price of 2.2% of face value.

During the twelve months ended June 30, 2008, we invested $222.8 million for portfolios with face values aggregating $6.1 billion for an average purchase price of 3.7% of face value. This is a $40.3 million increase, or 22.1%, in the amount invested compared with the $182.5 million invested during the twelve months ended June 30, 2007, to acquire portfolios with a face value aggregating $6.4 billion for an average purchase price of 2.9% of face value.

Subsequent to June 30, 2008, we ceased forward flow purchases of accounts from Jefferson Capital Group. See Note 12 “Subsequent Events,” to our unaudited condensed consolidated financial statements. Management believes that the supply of available credit card receivable portfolios for purchase in the markets will provide us with opportunities to purchase other portfolios that will generate returns at least comparable to that which we have been purchasing under the agreement with Jefferson Capital.

 

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Collections by Channel

During the three and six months ended June 30, 2008 and 2007, we utilized several business channels for the collection of charged-off credit card receivables and other charged-off receivables. The following table summarizes gross collections by collection channel (in thousands):

 

     Three Months Ended June 30,    Six Months Ended June 30,
     2008    2007    2008    2007

Collection sites

   $ 38,929    $ 32,516    $ 82,218    $ 66,511

Legal collections

     49,184      44,430      94,476      84,160

Collection agencies

     10,009      7,686      20,970      16,503

Sales

     3,633      7,972      7,847      15,269

Other

     375      1,007      974      1,709
                           

Gross collections for the period

   $ 102,130    $ 93,611    $ 206,485    $ 184,152
                           

Gross collections increased $8.5 million, or 9.1%, to $102.1 million during the three months ended June 30, 2008, from $93.6 million during the three months ended June 30, 2007.

Gross collections increased $22.3 million, or 12.1%, to $206.5 million during the six months ended June 30, 2008, from $184.2 million during the six months ended June 30, 2007.

Results of Operations

Results of operations in dollars and as a percentage of revenue were as follows (in thousands, except percentages):

 

     Three Months Ended June 30,  
     2008     2007  

Revenue

        

Revenue from receivable portfolios, net

   $ 66,275     94.7 %   $ 64,021     95.2 %

Servicing fees and other related revenue

     3,745     5.3 %     3,207     4.8 %
                            

Total revenue

     70,020     100.0 %     67,228     100.0 %
                            

Operating expenses

        

Salaries and employee benefits

     15,689     22.4 %     16,064     23.9 %

Stock-based compensation expense

     1,228     1.8 %     1,204     1.8 %

Cost of legal collections

     23,829     34.0 %     21,159     31.5 %

Other operating expenses

     5,987     8.6 %     6,239     9.3 %

Collection agency commissions

     3,781     5.4 %     2,867     4.2 %

General and administrative expenses

     4,581     6.5 %     4,232     6.3 %

Depreciation and amortization

     766     1.1 %     840     1.2 %
                            

Total operating expenses

     55,861     79.8 %     52,605     78.2 %
                            

Income before other (expense) income and income taxes

     14,159     20.2 %     14,623     21.8 %
                            

Other (expense) income

        

Interest expense

     (3,583 )   (5.1 %)     (3,336 )   (5.0 %)

Contingent interest expense

     —       0.0 %     (888 )   (1.3 %)

Pay-off of contingent interest

     —       0.0 %     (11,733 )   (17.4 %)

Gain on repurchase of debt, net

     1,417     2.0 %     —       0.0 %

Other income (expense)

     352     0.5 %     (42 )   (0.1 %)
                            

Total other expense

     (1,814 )   (2.6 %)     (15,999 )   (23.8 %)
                            

Income (loss) before income taxes

     12,345     17.6 %     (1,376 )   (2.0 %)

(Provision) benefit for income taxes

     (5,015 )   (7.1 %)     555     0.8 %
                            

Net income (loss)

   $ 7,330     10.5 %   $ (821 )   (1.2 %)
                            

 

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     Six Months Ended June 30,  
     2008     2007  

Revenue

        

Revenue from receivable portfolios, net

   $ 130,343     94.7 %   $ 126,174     95.2 %

Servicing fees and other related revenue

     7,231     5.3 %     6,429     4.8 %
                            

Total revenue

     137,574     100.0 %     132,603     100.0 %
                            

Operating expenses

        

Salaries and employee benefits

     30,540     22.2 %     33,250     25.1 %

Stock-based compensation expense

     2,322     1.7 %     2,005     1.5 %

Cost of legal collections

     44,135     32.1 %     38,780     29.2 %

Other operating expenses

     11,638     8.4 %     11,983     9.0 %

Collection agency commissions

     7,812     5.7 %     6,161     4.7 %

General and administrative expenses

     9,041     6.6 %     8,503     6.4 %

Depreciation and amortization

     1,488     1.1 %     1,709     1.3 %
                            

Total operating expenses

     106,976     77.8 %     102,391     77.2 %
                            

Income before other (expense) income and income taxes

     30,598     22.2 %     30,212     22.8 %
                            

Other (expense) income

        

Interest expense

     (7,529 )   (5.4 %)     (6,256 )   (4.7 %)

Contingent interest expense

     —       0.0 %     (4,123 )   (3.1 %)

Pay-off of contingent interest

     —       0.0 %     (11,733 )   (8.9 %)

Gain on repurchase of debt, net

     1,417     1.0 %     —       0.0 %

Other income

     373     0.3 %     74     0.1 %
                            

Total other expense

     (5,739 )   (4.1 %)     (22,038 )   (16.6 %)
                            

Income before income taxes

     24,859     18.1 %     8,174     6.2 %

Provision for income taxes

     (10,029 )   (7.3 %)     (3,338 )   (2.5 %)
                            

Net income

   $ 14,830     10.8 %   $ 4,836     3.7 %
                            

Comparison of Results of Operations

Revenue

Our revenue consists primarily of portfolio revenue and bankruptcy servicing revenue. Portfolio revenue consists of accretion revenue and zero basis revenue. Accretion revenue represents revenue derived from pools (quarterly groupings of purchased receivable portfolios) with a cost basis that has not been fully amortized. Revenue from pools with a remaining unamortized cost basis is accrued based on each pool’s effective interest rate applied to each pool’s remaining unamortized cost basis. The cost basis of each pool is increased by revenue earned and decreased by gross collections and impairments. The effective interest rate is the internal rate of return derived from the timing and amounts of actual cash received and anticipated future cash flow projections for each pool. All collections realized after the net book value of a portfolio has been fully recovered (“Zero Basis Portfolios”) are recorded as revenue (“Zero Basis Revenue”). We account for our investment in receivable portfolios utilizing the interest method in accordance with the provisions of the AICPA’s Statement of Position 03-3, “Accounting for Certain Debt Securities Acquired in a Transfer” (“SOP 03-3”). Servicing fee revenue is revenue primarily associated with bankruptcy servicing fees earned from our subsidiary, Ascension Capital Group, Inc. (“Ascension”), a provider of bankruptcy services to the finance industry.

Effective January 1, 2008, we revised our Unified Collection Score (“UCS”) and Behavioral Liquidation Score (“BLS”) methodologies by extending our collection forecast from 72 months to 84 months. UCS is a proprietary forecasting tool that generates portfolio level expectations of liquidation for portfolios that we have owned and serviced for more than six months. BLS forecasts portfolio level expectations based on credit characteristics for portfolios owned and serviced less than six months. We have observed that receivable portfolios purchased in 2001 and prior have consistently experienced cash collections beyond 72 months from the date of purchase. When we first developed our cash forecasting models in 2001, limited historical collection data was available with which to accurately model projected cash flows beyond 60 months. During the quarter ended June 30, 2006, we determined there was enough additional collection data accumulated over the previous several years, in addition to improvements in our forecasting tools,

 

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allowing us to extend the collection forecast to 72 months. During the quarter ended March 31, 2008, we determined that there was enough additional collection data to accurately extend the collection forecast in both our UCS and BLS models to 84 months. The increase in the collection forecast from 72 to 84 months was applied effective January 1, 2008, to each portfolio for which we could accurately forecast through such term and resulted in an increase in the aggregate total estimated remaining collections for the receivable portfolios by $67.3 million, or 7.5%, as of March 31, 2008. We did not extend the forecast on telecom portfolios as we do not anticipate significant collections past 72 months on these portfolios. The extension of the collection forecast was treated as a change in estimate and, in accordance with Statement of Financial Accounting Standard No. 154, “Accounting Changes and Error Corrections,” was recognized prospectively in our consolidated financial statements, effective January 1, 2008. In the quarter ended March 31, 2008, this prospective treatment resulted in a reduction in our net impairment provision of $3.1 million and an increase in revenue of $0.1 million. The impact of the change in estimate resulted in an increase in net income of $1.9 million and an increase in fully diluted earnings per share of $0.08 for the three months ended March 31, 2008. The impact of the change in estimate for the quarter ended June 30, 2008, was not material to our condensed consolidated financial statements.

The following tables summarize collections, revenue, end of period receivable balance and other related supplemental data by year of purchase (in thousands, except percentages):

 

     For the Three Months Ended
June 30, 2008
    As of
June 30, 2008
 
     Collections1    Gross
Revenue2
   Revenue
Recognition
Rate3
    Net
Reversal
(Impairment)
    Revenue
% of
Total
Revenue
    Unamortized
Balances
   Monthly
IRR
 

ZBA

   $ 2,623    $ 2,623    100.0 %   $ —       3.8 %   $ —      —    

2002

     1,603      1,108    69.1 %     140     1.6 %     1,080    28.9 %

2003

     3,880      3,170    81.7 %     (24 )   4.5 %     2,976    30.7 %

2004

     5,316      4,127    77.6 %     (721 )   5.9 %     16,575    7.9 %

2005

     18,576      12,383    66.7 %     (2,342 )   17.8 %     69,527    5.6 %

2006

     19,497      12,608    64.7 %     (336 )   18.1 %     79,001    5.1 %

2007

     37,059      23,977    64.7 %     (107 )   34.4 %     152,669    5.0 %

2008

     13,506      9,669    71.6 %     —       13.9 %     92,731    4.6 %
                                               

Total

   $ 102,060    $ 69,665    68.3 %   $ (3,390 )   100.0 %   $ 414,559    5.4 %
                                               
     For the Three Months Ended
June 30, 2007
    As of
June 30, 2007
 
     Collections1    Gross
Revenue2
   Revenue
Recognition
Rate3
    Net
Reversal
(Impairment)
    Revenue
% of
Total
Revenue
    Unamortized
Balances
   Monthly
IRR
 

ZBA

   $ 4,047    $ 4,047    100.0 %   $ —       6.5 %   $ —      —    

2002

     2,752      2,428    88.2 %     37     3.9 %     3,031    25.1 %

2003

     7,139      6,552    91.8 %     (112 )   10.4 %     6,756    30.6 %

2004

     9,687      6,883    71.1 %     758     10.9 %     27,113    7.9 %

2005

     29,776      18,970    63.7 %     1,202     30.1 %     105,984    5.6 %

2006

     24,006      16,347    68.1 %     (839 )   26.0 %     109,770    4.7 %

2007

     16,067      7,748    48.2 %     —       12.2 %     74,932    4.6 %
                                               

Total

   $ 93,474    $ 62,975    67.4 %   $ 1,046     100.0 %   $ 327,586    6.0 %
                                               

 

1

Does not include amounts collected on behalf of others.

2

Gross revenue excludes the effects of net impairment or net impairment reversals.

3

Revenue recognition rate excludes the effects of net impairment or net impairment reversals.

 

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Table of Contents
     For the Six Months Ended
June 30, 2008
    As of
June 30, 2008
 
     Collections1    Gross
Revenue2
   Revenue
Recognition
Rate3
    Net
Reversal
(Impairment)
    Revenue
% of
Total
Revenue
    Unamortized
Balances
   Monthly
IRR
 

ZBA

   $ 5,181    $ 5,181    100.0 %   $ —       3.7 %   $ —      —    

2002

     3,268      2,459    75.2 %     71     1.8 %     1,080    28.9 %

2003

     8,069      6,951    86.1 %     (313 )   4.9 %     2,976    30.8 %

2004

     11,353      8,792    77.4 %     (1,577 )   6.3 %     16,575    7.9 %

2005

     39,512      26,359    66.7 %     (4,645 )   19.0 %     69,527    5.6 %

2006

     41,072      26,548    64.6 %     (2,154 )   19.1 %     79,001    5.1 %

2007

     77,091      49,594    64.3 %     (107 )   35.7 %     152,669    5.0 %

2008

     20,794      13,184    63.4 %     —       9.5 %     92,731    4.6 %
                                               

Total

   $ 206,340    $ 139,068    67.4 %   $ (8,725 )   100.0 %   $ 414,559    5.4 %
                                               
     For the Six Months Ended
June 30, 2007
    As of
June 30, 2007
 
     Collections1    Gross
Revenue2
   Revenue
Recognition
Rate3
    Net
Reversal
(Impairment)
    Revenue
% of
Total
Revenue
    Unamortized
Balances
   Monthly
IRR
 

ZBA

   $ 9,155    $ 9,155    100.0 %   $ —       7.3 %   $ —      —    

2002

     6,199      5,334    86.0 %     332     4.3 %     3,031    25.1 %

2003

     16,295      14,258    87.5 %     (102 )   11.3 %     6,756    30.6 %

2004

     20,336      14,580    71.7 %     (250 )   11.7 %     27,113    7.9 %

2005

     61,074      37,511    61.4 %     2,122     30.0 %     105,984    5.6 %

2006

     49,224      33,800    68.7 %     (839 )   27.1 %     109,770    4.7 %

2007

     21,603      10,273    47.6 %     —       8.3 %     74,932    4.6 %
                                               

Total

   $ 183,886    $ 124,911    67.9 %   $ 1,263     100.0 %   $ 327,586    6.0 %
                                               

 

1

Does not include amounts collected on behalf of others.

2

Gross revenue excludes the effects of net impairment or net impairment reversals.

3

Revenue recognition rate excludes the effects of net impairment or net impairment reversals.

Total revenue was $70.0 million for the three months ended June 30, 2008, an increase of $2.8 million, or 4.2%, compared to total revenue of $67.2 million for the three months ended June 30, 2007. Portfolio revenue was $66.3 million for the three months ended June 30, 2008, an increase of $2.3 million, or 3.5%, compared to portfolio revenue of $64.0 million for the three months ended June 30, 2007.

Total revenue was $137.6 million for the six months ended June 30, 2008, an increase of $5.0 million, or 3.8%, compared to total revenue of $132.6 million for the six months ended June 30, 2007. Portfolio revenue was $130.3 million for the six months ended June 30, 2008, an increase of $4.1 million, or 3.3%, compared to portfolio revenue of $126.2 million for the six months ended June 30, 2007.

The increase of portfolio revenue for the three and six months ended June 30, 2008, was primarily the result of additional accretion revenue associated with higher purchasing volumes and, as discussed above, from the extension of our collection forecast from 72 to 84 months. The increase was partially offset by a greater portion of our revenues coming from our 2004 to 2008 portfolio purchases that have lower effective accretion rates than our 2003 and prior purchases, due to a more competitive pricing environment since 2004, and the recording of a larger impairment provision on certain portfolios during the quarter. During the three months ended June 30, 2008, we recorded a net impairment provision of $3.4 million, compared to a net impairment provision reversal of $1.0 million during the same period in the prior year. During the six months ended June 30, 2008, we recorded a net impairment provision of $8.7 million, compared to a net impairment provision reversal of $1.3 million during the same period in the prior year. The increase in impairment for the three and six months ended June 30, 2008, was primarily due to two factors. First, we experienced a shortfall in collections in certain pool groups against our forecast, primarily our 2004, 2005 and 2006 vintages. In these pool groups, we continued to experience a trend in which a larger percentage of collections from our legal channel come from multi-payment settlements versus single-payment settlements. Despite this recent trend in the shift in payment types from single-payment settlements to multi-payment settlements in our legal channel, we have not experienced any material shifts in our overall payer rates or settlement

 

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rates. Given the high monthly IRRs in our portfolios, when payments are extended over a longer period of time and the cash flows are delayed, this generally results in an impairment provision, even if we ultimately receive the collections in the future. Second, as of March 31, 2008, we decided not to pursue certain collections with a very high cost to collect, primarily low balance telecom accounts. This resulted in a reduction in expected future cash flow from these accounts and increased our impairment provision.

Revenue associated with bankruptcy servicing fees earned from Ascension was $3.7 million for the three months ended June 31, 2008, an increase of $0.5 million, or 17.5%, compared to revenue of $3.2 million for the three months ended June 30, 2007. Revenue associated with bankruptcy servicing fees earned from Ascension was $7.2 million for the six months ended June 31, 2008, an increase of $0.8 million, or 12.7%, compared to revenue of $6.4 million for the six months ended June 30, 2007. The increase in Ascension revenue for the three and six months ended June 30, 2008, is due to the slightly higher volume of bankruptcy placements.

Operating Expenses

Total operating expenses were $55.9 million for the three months ended June 30, 2008, an increase of $3.3 million, or 6.2%, compared to total operating expenses of $52.6 million for the three months ended June 30, 2007.

Total operating expenses were $107.0 million for the six months ended June 30, 2008, an increase of $4.6 million, or 4.5%, compared to total operating expenses of $102.4 million for the six months ended June 30, 2007.

Operating expenses are explained in more detail as follows:

Salaries and employee benefits

Total salaries and employee benefits decreased by $0.4 million, or 2.3%, to $15.7 million during the three months ended June 30, 2008, from $16.1 million during the three months ended June 30, 2007. The decrease was primarily the result of a decrease of $1.2 million in salaries and related payroll taxes and benefits resulting from the reduction in our workforce, primarily attributable to our cost savings initiatives implemented in September 2007. The decrease was partially offset by an increase of $0.3 million in personnel severance expenses, an increase of $0.3 million in call center bonuses and an increase of $0.2 million in health and life insurance costs.

Total salaries and employee benefits decreased by $2.7 million, or 8.5%, to $30.6 million during the six months ended June 30, 2008, from $33.3 million during the six months ended June 30, 2007. The decrease was primarily the result of a decrease of $3.1 million in salaries and related payroll taxes and benefits resulting from the reduction in our workforce, primarily attributable to our cost savings initiatives implemented in September 2007. The decrease was partially offset by an increase of $0.3 million in call center bonuses and an increase of $0.1 million in health and life insurance costs.

Stock-based compensation expenses

Stock-based compensation expense remained consistent at $1.2 million, during the three months ended June 30, 2008 and 2007.

Stock-based compensation expense increased by $0.3 million, or 15.8%, to $2.3 million during the six months ended June 30, 2008, from $2.0 million for the six months ended June 30, 2007. The increase was attributable to a $0.4 million actual versus estimated forfeiture true-up adjustment, and the result of a one-time reduction in expense in the six months ended March 31, 2007, due to change of assumptions used during that period. This true-up resulted in a reduction in stock-based compensation expense of $0.4 million for the three months ended March 31, 2007. The increase was partially offset by a reduction in expenses as a result of fewer grants and the decreased fair value of stock options granted in recent years.

Cost of legal collections

The cost of legal collections increased $2.6 million, or 12.6%, to $23.8 million during the three months ended June 30, 2008, compared to $21.2 million during the three months ended June 30, 2007. These costs represent contingent fees paid to our nationwide network of attorneys and costs of litigation. The increase in the cost of legal collections was primarily the result of an increase of $4.8 million, or 10.7%, in gross collections through our legal channel and upfront litigation costs. Gross legal collections amounted to $49.2 million during the three months ended June 30, 2008, compared to $44.4 million collected during the three months ended June 30, 2007. The cost of legal collections as a percent of gross collections through this channel, increased to 48.4% during the three months ended June 30, 2008, from 47.6% during the three months ended June 30, 2007, due to an increase in upfront court costs expensed associated with our pursuit of legal collections, an increase in costs related to counter claims, partially offset by the effect of extending the recovery period of deferred court costs and a lower overall commission rate, driven by lower bonus commissions paid to our law firms.

 

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The cost of legal collections increased $5.3 million, or 13.8%, to $44.1 million during the six months ended June 30, 2008, compared to $38.8 million during the six months ended June 30, 2007. These costs represent contingent fees paid to our nationwide network of attorneys and costs of litigation. The increase in the cost of legal collections was primarily the result of an increase of $10.3 million, or 12.3%, in gross collections through our legal channel and upfront litigation costs. Gross legal collections amounted to $94.5 million during the three months ended June 30, 2008, compared to $84.2 million collected during the six months ended June 30, 2007. The cost of legal collections as a percent of gross collections through this channel increased to 46.7% during the six months ended June 30, 2008, from 46.1% during the six months ended June 30, 2007, due to an increase in upfront court costs expensed associated with our pursuit of legal collections, an increase in costs related to counter claims, offset by the effect of extending the recovery period of deferred court costs and a lower overall commission rate, driven by lower bonus commissions paid to our law firms.

Other operating expenses

Other operating expenses decreased $0.2 million, or 4.1%, to $6.0 million during the three months ended June 30, 2008, from $6.2 million during the three months ended June 30, 2007. The decrease was primarily the result of a decrease of $0.2 million in employee moving expenses, a decrease of $0.3 million in skip tracing expenses and a decrease of $0.2 million in the amortization of a previously acquired deferred revenue asset. The decrease was partially offset by an increase of $0.3 million in Ascension legal expenses and a net increase of $0.2 million in various other operating expenses.

Other operating expenses decreased $0.4 million, or 2.9%, to $11.6 million during the six months ended June 30, 2008, from $12.0 million during the six months ended June 30, 2007. The decrease was primarily the result of a decrease of $0.5 million in employee moving expenses, a decrease of $0.2 million in recruiting expenses, a decrease of $0.5 million in skip tracing expenses and a decrease of $0.4 million in the amortization of a previously acquired deferred revenue asset. The decrease was partially offset by an increase of $0.2 million in Ascension legal expenses, an increase of $0.8 million related to direct mail campaign expenses and a net increase of $0.2 million in various other operating expenses.

Collection agency commissions

During the three months ended June 30, 2008, we incurred $3.8 million in commissions to third party collection agencies, or 37.8% of the related gross collections of $10.0 million compared to $2.9 million in commissions, or 37.3% of the related gross collections of $7.7 million, during the three months ended June 30, 2007. The increase in commissions was consistent with the increase in collections through this channel. The increase in the commission rate as a percentage of the related gross collections is primarily due to the mix of accounts placed with the agencies. Commissions, as a percentage of collections in this channel, vary from period to period depending on, among other things, the time from charge-off of the accounts placed with an agency. Generally, freshly charged-off accounts have a lower commission rate than accounts that have been charged off for a longer period of time.

During the six months ended June 30, 2008, we incurred $7.8 million in commissions to third party collection agencies, or 37.3% of the related gross collections of $21.0 million, compared to $6.2 million in commissions, or 37.3% of the related gross collections of $16.5 million, during the three months ended June 30, 2007. The increase in commissions was consistent with the increase in collections through this channel.

General and administrative expenses

General and administrative expenses increased $0.4 million, or 8.2%, to $4.6 million during the three months ended June 30, 2008, from $4.2 million during the three months ended June 30, 2007. The increase was primarily the result of an increase of $0.5 million in corporate legal expenses, and litigation settlement costs and an increase of $0.4 million in various corporate insurance costs compared to the same period of the prior year, which included a $0.6 million release of reserves in the previously self insured workers compensation plan. The increase was partially offset by a decrease of $0.2 million in costs associated with computer system maintenance and a net decrease of $0.3 million in expenses associated with general corporate matters.

General and administrative expenses increased $0.5 million, or 6.3%, to $9.0 million during the six months ended June 30, 2008, from $8.5 million during the six months ended June 30, 2007. The increase was primarily the result of an increase of $0.7 million in corporate legal expenses, and litigation settlement costs and an increase of $0.4 million in various corporate insurance costs compared to the same period of the prior year, which included a $0.6 million release of reserves in the previously self insured workers compensation plan. The increase was partially offset by a decrease of $0.4 million in accounting and consulting service fees incurred in the prior year related to the filing of our 1999-2005 state tax returns and a decrease of $0.2 million in costs associated with the strategic alternatives process.

 

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Table of Contents

Depreciation and amortization

Depreciation and amortization expense remained consistent at $0.8 million during the three months ended June 30, 2008 and 2007. Depreciation and amortization expense decreased $0.2 million, or 12.9%, to $1.5 million during the six months ended June 30, 2008, from $1.7 million during the six months ended June 30, 2007. Depreciation expense was $1.1 million for the six months ended June 30, 2008, compared to $1.2 million for the six months ended June 30, 2007. Amortization expense relating to intangible assets acquired in conjunction with the acquisition of Ascension was $0.4 million for the six months ended June 30, 2008, compared to $0.5 million for the six months ended June 30, 2007.

Interest expense

Total interest expense decreased $12.4 million, or 77.5%, to $3.6 million during the three months ended June 30, 2008, from $16.0 million during the three months ended June 30, 2007.

Total interest expense decreased $14.6 million, or 66.0%, to $7.5 million during the six months ended June 30, 2008, from $22.1 million during the six months ended June 30, 2007.

The following tables summarize our interest expense (in thousands, except percentages):

 

     For the Three Months Ended June 30,  
     2008    2007    $ Change     % Change  

Stated interest on debt obligations

   $ 3,227    $ 2,951    $ 276     9.4 %

Amortization of loan fees and other loan costs

     356      385      (29 )   (7.5 %)
                            

Subtotal

     3,583      3,336      247     7.4 %

Contingent interest

     —        888      (888 )   (100.0 %)

Pay-off of contingent interest

     —        11,733      (11,733 )   (100.0 %)
                        

Total interest expense

   $  3,583    $ 15,957    $ (12,374 )   (77.5 %)
                        
     For the Six Months Ended June 30,  
     2008    2007    $ Change     % Change  

Stated interest on debt obligations

   $ 6,806    $ 5,475    $ 1,331     24.3 %

Amortization of loan fees and other loan costs

     723      781      (58 )   (7.4 %)
                            

Subtotal

     7,529      6,256      1,273     20.3 %

Contingent interest

     —        4,123      (4,123 )   (100.0 %)

Pay-off of contingent interest

     —        11,733      (11,733 )   (100.0 %)
                        

Total interest expense

   $ 7,529    $ 22,112    $ (14,583 )   (66.0 %)
                        

As of December 31, 2004, we no longer made borrowings under our Secured Financing Facility. As of December 31, 2006, we repaid in full the principal balance of our Secured Financing Facility. Prior to May 7, 2007, we shared with the lender the residual collections on purchases made under this facility, net of servicing fees paid to us. The residual collections paid to the lender were classified as contingent interest. On May 7, 2007, we entered into an agreement with the lender under our Secured Financing Facility to eliminate all future Contingent Interest payments for a one-time payment of $16.9 million. This agreement effectively eliminated all future Contingent Interest payments and released our lender’s security interests in the remaining receivables originally financed under our Secured Financing Facility. Subsequent to the second quarter of 2007, we no longer are required to pay any Contingent Interest expense under the Secured Financing Facility.

We have financed portfolio purchases subsequent to December 31, 2004 using our Revolving Credit Facility, which does not require the sharing of residual collections with the lender. See Note 7 to the unaudited condensed consolidated financial statements for a further discussion of our Revolving Credit Facility.

 

29


Table of Contents

Gain on repurchase of debt, net

In April 2008, we repurchased $5.0 million principal amount of our outstanding convertible senior notes, for a total price of $3.5 million, plus accrued interest. This transaction left $95.0 million principal amount of our convertible senior notes outstanding. This repurchase also resulted in a pre-tax gain of $1.5 million, which was partially offset by a $0.1 million write-off of the debt issuance costs related to the portions of the senior convertible notes repurchased. The net gain of $1.4 million was recognized in our consolidated statement of operations for the three and six months ended June 30, 2008.

Other income and expense

During the three months ended June 30, 2008, total other income was $0.4 million, compared to other expense of less than $0.1 million for the three months ended June 30, 2007. The increase was primarily attributable to a $0.3 million gain recognized in connection with early termination of a contract.

During the six months ended June 30, 2008, total other income was $0.4 million, compared to other income of $0.1 million for the six months ended June 30, 2007. The increase was attributable to a $0.3 million gain recognized in connection with early termination of a contract.

Provision for income taxes

During the three months ending June 30, 2008, we recorded an income tax provision of $5.0 million, reflecting an effective rate of 40.6% of pretax income. Our effective tax rate for the three months ended June 30, 2008, differed from the Federal statutory rate primarily due to the net effect of state taxes and the effect of permanent book versus tax differences. For the three months ended June 30, 2007, we recorded an income tax benefit of $0.6 million, reflecting an effective rate of 40.3% of pretax income. Our effective tax rate for the three months ended June 30, 2007, differed from the Federal statutory rate primarily due to the net effect of state taxes, and the effect of permanent book versus tax differences. The increase in our effective tax rate was the result of the changing mix of permanent book versus tax differences relative to higher taxable income.

During the six months ended June 30, 2008, we recorded an income tax provision of $10.0 million, reflecting an effective rate of 40.3% of pretax income. Our effective tax rate for the six months ended June 30, 2008, differed from the Federal statutory rate primarily due to the net effect of state taxes. For the six months ended June 30, 2007, we recorded an income tax provision of $3.3 million, reflecting an effective rate of 40.8% of pretax income. Our effective tax rate for the six months ended June 30, 2007, differed from the Federal statutory rate primarily due to the net effect of state taxes. The decrease in our effective tax rate was the result of the changing mix of permanent book versus tax differences relative to taxable income. See Note 8 to the unaudited condensed consolidated financial statements for a further discussion of income taxes.

 

30


Table of Contents

Supplemental Performance Data

Cumulative Collections to Purchase Price Multiple

The following table summarizes our purchases and related gross collections by year of purchase (in thousands, except multiples):

 

Year of
Purchase

  Purchase
Price1
    Cumulative Collections through June 30, 2008    
    <2001   2001   2002   2003   2004   2005   2006   2007   2008   Total2   CCM3

<1999

  $ 41,117 4   $ 88,629   $ 22,545   $ 15,007   $ 7,546   $ 4,202   $ 2,042   $ 1,513   $ 989   $ 305   $ 142,778   3.5

  1999

    48,805       29,163     19,174     16,259     11,508     8,654     5,157     3,513     1,954     677     96,059   2.0

  2000

    6,153       5,489     7,172     4,542     4,377     2,293     1,323     1,007     566     196     26,965   4.4

  2001

    38,186       —       21,197     54,184     33,072     28,551     20,622     14,521     5,644     1,728     179,519   4.7

  2002

    61,496       —       —       48,322     70,227     62,282     45,699     33,694     14,902     4,682     279,808   4.6

  2003

    88,524       —       —       —       59,038     86,958     69,932     55,131     26,653     8,083     305,795   3.5

  2004

    101,339       —       —       —       —       39,400     79,845     54,832     34,625     11,352     220,054   2.2

  2005

    192,855       —       —       —       —       —       66,491     129,809     109,078     39,944     345,322   1.8

  2006

    142,048       —       —       —       —       —       —       42,354     92,265     41,072     175,691   1.2

  2007

    204,667       —       —       —       —       —       —       —       68,048     77,091     145,139   0.7

  2008

    100,340       —       —       —       —       —       —       —       —       21,210     21,210   0.2
                                                                       

  Total

  $ 1,025,530     $ 123,281   $ 70,088   $ 138,314   $ 185,768   $ 232,340   $ 291,111   $ 336,374   $ 354,724   $ 206,340   $ 1,938,340   1.9
                                                                       

 

1

Adjusted for put-backs, account recalls, purchase price rescissions, and the impact of an acquisition in 2000. Put-backs represent accounts that are returned to the seller in accordance with the respective purchase agreement (“Put-Backs”). Recalls represents accounts that are recalled by the seller in accordance with the respective purchase agreement (“Recalls”).

2

Cumulative collections from inception through June 30, 2008.

3

Cumulative Collections Multiple (“CCM”) through June 30, 2008 – collections as a multiple of purchase price.

4

From inception through December 31, 1998.

Total Estimated Collections to Purchase Price Multiple

The following table summarizes our purchases, resulting historical gross collections, and estimated remaining gross collections by year of purchase (in thousands, except multiples):

 

     Purchase Price1     Historical Gross
Collections2
   Estimated
Remaining
Collections3,4
   Total Estimated
Gross Collections
   Total Estimated Gross
Collections to Purchase
Price

<1999

   $ 41,117 5   $ 142,778    $ 359    $ 143,137    3.5

  1999

     48,805       96,059      1,165      97,224    2.0

  2000

     6,153       26,965      323      27,288    4.4

  2001

     38,186       179,519      2,157      181,676    4.8

  2002

     61,496       279,808      6,558      286,366    4.7

  2003

     88,524       305,795      15,505      321,300    3.6

  2004

     101,339       220,054      40,899      260,953    2.6

  2005

     192,855       345,322      155,018      500,340    2.6

  2006

     142,048       175,691      188,905      364,596    2.6

  2007

     204,667       145,139      346,708      491,847    2.4

  2008

     100,340       21,210      231,978      253,188    2.5
                                 

  Total

   $ 1,025,530     $ 1,938,340    $ 989,575    $ 2,927,915    2.9
                                 

 

1

Adjusted for Put-Backs, Recalls, purchase price rescissions, and the impact of an acquisition in 2000.

2

Cumulative collections from inception through June 30, 2008.

3

Includes $1.3 million in expected collections for the healthcare portfolios on cost recovery.

4

Effective January 1, 2008, we revised our UCS and BLS methodologies by extending our collection forecast from 72 months to 84 months.

5

From inception through December 31, 1998.

 

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Estimated Remaining Gross Collections by Year of Purchase

The following table summarizes our estimated remaining gross collections by year of purchase (in thousands):

 

     Estimated Remaining Gross Collections by Year of Purchase
     20082    2009    2010    2011    2012    2013    2014    2015    Total

<19991

   $ 175    $ 184    $ —      $ —      $ —      $ —      $ —      $ —      $ 359

  19991

     544      609      12      —        —        —        —        —        1,165

  20001

     147      175      1      —        —        —        —        —        323

  20011

     917      1,134      106      —        —        —        —        —        2,157

  20021

     3,195      3,245      118      —        —        —        —        —        6,558

  2003

     5,561      7,678      2,266      —        —        —        —        —        15,505

  2004

     9,911      15,822      10,364      4,802      —        —        —        —        40,899

  2005

     35,114      51,363      35,260      24,209      9,072      —        —        —        155,018

  2006

     34,771      53,333      38,953      29,811      21,787      10,250      —        —        188,905

  2007

     65,437      110,470      69,259      46,470      31,997      18,234      4,841      —        346,708

  2008

     31,127      65,354      48,542      34,140      24,584      16,516      9,851      1,864      231,978
                                                              

  Total

   $ 186,899    $ 309,367    $ 204,881    $ 139,432    $ 87,440    $ 45,000    $ 14,692    $ 1,864    $ 989,575
                                                              

 

1

Estimated remaining collections for Zero Basis Portfolios can extend beyond the 84-month accrual basis collection forecast.

2

2008 amount consists of six months data, from July 1, 2008 to December 2008.

Unamortized Balances of Portfolios

The following table summarizes the remaining unamortized balances of our purchased receivable portfolios by year of purchase as of June 30, 2008 (in thousands, except percentages):

 

     Unamortized Balance
as of June 30, 20081
   Purchase Price2    Unamortized Balance
as a Percentage of
Purchase Price
    Unamortized Balance
as a Percentage of
Total
 

2002

   $ 1,080    $ 61,496    1.8 %   0.3 %

2003

     2,976      88,524    3.4 %   0.7 %

2004

     16,575      101,339    16.4 %   4.0 %

2005

     69,527      192,855    36.1 %   16.8 %

2006

     79,001      142,048    55.6 %   19.1 %

2007

     152,669      204,667    74.6 %   36.7 %

2008

     92,731      100,340    92.4 %   22.4 %
                          

Total

   $ 414,559    $ 891,269    46.5 %   100.0 %
                          

 

1

Includes $1.3 million for healthcare portfolios being accounted for on the cost recovery method.

2

Purchase price refers to the cash paid to a seller to acquire a portfolio less Put- Backs, plus allocation of our forward flow asset (if applicable), and less the purchase price for accounts that were sold at the time of purchase to another debt purchaser.

Collections by Channel

During the three and six months ended June 30, 2008 and 2007, we utilized several business channels for the collection of charged-off credit card receivables and other charged-off receivables. The following table summarizes gross collections by collection channel (in thousands):

 

     Three Months Ended June 30,    Six Months Ended June 30,
     2008    2007    2008    2007

Collection sites

   $ 38,929    $ 32,516    $ 82,218    $ 66,511

Legal collections

     49,184      44,430      94,476      84,160

Collection agencies

     10,009      7,686      20,970      16,503

Sales

     3,633      7,972      7,847      15,269

Other

     375      1,007      974      1,709
                           

Gross collections for the period

   $ 102,130    $ 93,611    $ 206,485    $ 184,152
                           

 

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External Collection Channels and Related Direct Costs

The following tables summarize our external collection channel performance and related direct costs (in thousands, except percentages):

 

     Legal Collections
Three Months Ended June 30,
    Collection Agencies
Three Months Ended June 30,
 
     2008     2007     2008     2007  

Collections

   $ 49,184    100.0 %   $ 44,430    100.0 %   $ 10,009    100.0 %   $ 7,686    100.0 %

Commissions

   $ 14,169    28.8 %   $ 12,964    29.1 %   $ 3,781    37.8 %   $ 2,867    37.3 %

Court cost expense1

     8,581    17.4 %     8,029    18.1 %     —      —         —      —    

Other2

     1,079    2.2 %     166    0.4 %     —      —         —      —    
                                                    

Total Costs

   $ 23,829    48.4 %   $ 21,159    47.6 %   $ 3,781    37.8 %   $ 2,867    37.3 %
                                                    
     Legal Collections
Six Months Ended June 30,
    Collection Agencies
Six Months Ended June 30,
 
     2008     2007     2008     2007  

Collections

   $ 94,476    100.0 %   $ 84,160    100.0 %   $ 20,970    100.0 %   $ 16,503    100.0 %

Commissions

   $ 26,985    28.6 %   $ 24,847    29.5 %   $ 7,812    37.3 %   $ 6,161    37.3 %

Court cost expense1

     15,250    16.1 %     13,562    16.1 %     —      —         —      —    

Other2

     1,900    2.0 %     371    0.5 %     —      —         —      —    
                                                    

Total Costs

   $ 44,135    46.7 %   $ 38,780    46.1 %   $ 7,812    37.3 %   $ 6,161    37.3 %
                                                    

 

1

In connection with our agreement with contracted attorneys, we advance certain out-of-pocket court costs. We capitalize these costs in our consolidated financial statements and provide a reserve and corresponding court cost expense for the costs that we believe will be ultimately uncollectible. This amount includes changes in our anticipated recovery rate of court costs expensed.

2

Other costs consist primarily of costs related to counter claims.

Legal Outsourcing Collections and Related Costs

The following tables summarize our legal outsourcing collection channel performance and related direct costs (in thousands, except percentages):

 

     Gross Collections by Year of Collection1

Placement Year

   2003    2004    2005    2006    2007    2008    Total
Collections

2003

   $ 10,750    $ 27,192    $ 17,212    $ 9,566    $ 5,561    $ 1,779    $ 72,060

2004

     —      $ 23,455    $ 37,674    $ 21,676    $ 12,029    $ 3,443    $ 98,277

2005

     —        —      $ 21,694    $ 40,762    $ 22,152    $ 6,309    $ 90,917

2006

     —        —        —      $ 39,395    $ 82,740    $ 25,989    $ 148,124

2007

     —        —        —        —      $ 41,958    $ 45,864    $ 87,822

20082

     —        —        —        —        —      $ 9,549    $ 9,549

 

1       Includes collections for accounts placed in our legal channel beginning January 1, 2003. We continue to collect on accounts placed in this channel prior to that date.

2       2008 amount consists of six months data, from January 1, 2008, to June 30, 2008.

     Court Costs by Year of Collection1

Placement Year

   2003    2004    2005    2006    2007    2008    Total
Court Costs

2003

   $ 908    $ 2,046    $ 571    $ 300    $ 147    $ 38    $ 4,010

2004

     —      $ 2,509    $ 2,937    $ 1,087    $ 406    $ 100    $ 7,039

2005

     —        —      $ 3,271    $ 4,426    $ 859    $ 167    $ 8,723

2006

     —        —        —      $ 10,158    $ 10,291    $ 1,018    $ 21,467

2007

     —        —        —        —      $ 15,357    $ 7,949    $ 23,306

20082

     —        —        —        —        —      $ 4,625    $ 4,625

 

1

Includes court cost expense for accounts placed in our legal channel beginning January 1, 2003. We continue to incur court cost expense on accounts placed in this channel prior to that date. Court cost expense in this table is calculated based on our blended court cost expense rate.

2

2008 amount consists of six months data, from January 1, 2008, to June 30, 2008.

 

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Table of Contents
     Commissions by Year of Collection1  

Placement Year

   2003     2004     2005     2006     2007     2008     Total
Commissions
 

2003

   $ 3,574     $ 8,606     $ 5,496     $ 2,898     $ 1,574     $ 504     $ 22,652  

2004

     —       $ 7,273     $ 12,060     $ 6,653     $ 3,498     $ 992     $ 30,476  

2005

     —         —       $ 6,725     $ 12,108     $ 6,364     $ 1,798     $ 26,995  

2006

     —         —         —       $ 11,451     $ 23,659     $ 7,380     $ 42,490  

2007

     —         —         —         —       $ 11,845     $ 13,066     $ 24,911  

20082

     —         —         —         —         —       $ 2,697     $ 2,697  

 

1       Includes commissions for accounts placed in our legal channel beginning January 1, 2003. We continue to incur commissions on collections for accounts placed
in this channel prior to that date.

2       2008 amount consists of six months data, from January 1, 2008, to June 30, 2008.

          

         

     Court Cost Expense and Commissions as a % of Gross Collections
by Year of Collection
 

Placement Year

   2003     2004     2005     2006     2007     2008     Cumulative
Average
 

2003

     41.7 %     39.2 %     35.2 %     33.4 %     31.0 %     30.5 %     37.0 %

2004

     —         41.7 %     39.8 %     35.7 %     32.4 %     31.7 %     38.2 %

2005

     —         —         46.1 %     40.6 %     32.6 %     31.2 %     39.3 %

2006

     —         —         —         54.9 %     41.0 %     32.3 %     43.2 %

2007

     —         —         —         —         64.8 %     45.8 %     54.9 %

20081

     —         —         —         —         —         76.7 %     76.7 %

 

1       2008 amount consists of six months data, from January 1, 2008, to June 30, 2008.

         

     Lawsuits Filed by Year1  

Placement Year2

   2003     2004     2005     2006     2007     2008     Total  

2003

     23       29       5       2       —         —         59  

2004

     —         59       39       11       2       —         111  

2005

     —         —         76       46       3       —         125  

2006

     —         —         —         205       105       3       313  

2007

     —         —         —         —         269       92       361  

20083